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What is the Free
Market&
'(a)italism*
2
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+ (hara,teristi,s of Free Markets1- Little government involvement in the e,onom.-
'Laisse Faire 0 Let it #e*2- ndividuals W resour,es and determine 3hat and
ho3 to )rodu,e4 and 3ho gets 3hat5s )rodu,ed-
- The o))ortunit. to make "RFT gives )eo)le(7T87 to )rodu,e 9ualit. items effi,ientl.-
- Wide variet. of goods availa#le to ,onsumers-
+- (om)etition and $elf;nterest 3ork together to
regulate the e,onom.-
3
The government5s
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@oes the Free
Market ever F!Lto meet so,iet.5s
needs&
5
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What is a Market Failure&! situation in 3hi,h the free;market s.stem
fails to satisf. so,iet.5s 3ants-
'When the invisi#le hand doesn5t 3ork-*
"rivate markets do not effi,ientl. #ring
a#out the allo,ation of resour,es-
What5s the resultA
The government must ste) in tosatisf. so,iet.5s 3ants-
(ir,ular Flo3 Model Revie3 6
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7
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?o3 does the freemarket F!L&
8
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The Four Market Failures
We 3ill fo,us on four different marketfailures:1- "u#li, Goods
2- 7=ternalities 'third;)erson side effe,ts*- Mono)olies
- Unfair distri#ution of in,ome
n ea,h of the a#ove situations4the government ste)s in to
allo,ate resour,es more effi,ientl.-
9
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Market Failure %1:
"U>L( G@$
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f there 3as no government4 ho3 3ould
s,hools4 )arks and free3a.s #e different&
Would there #e enough to meet our needs&
"u#li, Goods
11
8ideo: Fire @e)artment
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Wh. must the government )rovide )u#li,
goods and servi,es&
t is im)ra,ti,al for the free;market to
)rovide these goods #e,ause there is littleo))ortunit. to earn )rofit-
This is #e,ause of the Free;Rider "ro#lem
Free Riders are individuals 3ho#enefit 3ithout )a.ing-
"u#li, Goods
12
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What5s 3rong 3ith this )i,ture&
13
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The Free Rider
"ro#lem
14
7=am)les:1- "eo)le 3ho do3nload musi, illegall.
2- "eo)le 3ho 3at,h a street )erformer and don5t )a.
- Teenagers 3ho live at home and don5t have a
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15
(anadian
Militar.$)ending:
B21-C >illion
U-$- Militar.$)ending:
B66D >illion
Wh. doesn5t
(anada s)end
more on its
militar.&
@oes an.one free ride off .ou&
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Free Riders kee) firms
from making )rofits-f left to the free market4
essential servi,es 3ould
#e under;)rodu,ed-
To solve the )ro#lem4 the
government ,an:
1- Find ne3 3a.s to
)unish free riders-2- Use ta= dollars to
)rovide the servi,e to
ever.one-
What5s 3rong 3ith Free Riders&
16
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The Final 7=am
am 3illing to give 1DDE on the finale=am to 3hi,hever ,lass gives me B14DDD-
7ver.one in the ,lass 3ill get 1DDE even if
the. don5t )a.-
Who is 3illing to )a.&What a#out those 3ho refuse to )a.&
$olution&
787R7 )a.s a mandator. ta=
and all re,eive the same #enefits- 17
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@efinition of "u#li,Goods
18
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dentif. 3hi,h of the follo3ing are
TRU7 )u#li, goods
'have non;e=,lusion and non;rival,onsum)tion*:
1- ?am#urgers2- (a#le T8
- Free "u#li, 7du,ation
- ?omes
+- $treet lights
6- ?igh3a.s20
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When should thegovernment get involved in
the e,onom.&
21
Worker $afet. La3s >ar#er $ho) Li,enses
7ver. so,iet. needs to de,ide ho3 mu,h
government involvement is desira#le
>ank >ailouts
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Unit 6:Market Failures and theRole of the Government
22
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Revie3
1- List the ,hara,teristi,s of the Free Market-
2- @efine Market Failure-- What is the invisi#le handH&
- List the Market Failures-
+- Wh. must the government )rovide )u#li,
goods&
6- @efine Free Rider-
I- What is 3rong 3ith having free riders&
C- List 1D streets in Roseville/Granite >a.-
23
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Wh. doesn5t the free market)rovide them&
There is little o))ortunit. to earn)rofit-
Wh. T&
ndividuals #enefit 3ithout )a.ing-
Market Failure %1
"U>L( G@$
24
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?o3 do 3e de,ide
ho3 man. )u#li,
goods 3e need&
25
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(an the governmentA1- "revent 3ild fires in "la,er (ount.
forever&2- 7nsure that no one ever s)eeds on the
free3a.&
- (reate a resear,h station on Mars&- $to) )ollution from fossil fuels&
+- (om)letel. sto) illegal immigration&
6- Make sure ever.one in the U-$- has a ut the ,osts out3eigh the #enefits-
?o3 does the government de,ide ho3
man. )u#li, goods to )rovide&
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?o3 does the government determine 3hat
9uantit. of )u#li, goods to )rodu,e&
t uses 'sur)riseJ* $u))l. and @emand
@emand for "u#li, Goods;
The Marginal $o,ial >enefit of the good as
determined #. ,itiens5 3illingness to )a.-
$u))l. of "u#li, Goods;
The Marginal $o,ial (ost of )roviding
additional 9uantities/amounts of the good-
8ideo: @am Traged.
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@emand for a e3 "ark
Marginal 3illingness to )a. higher ta=es
% of"arks
!dam is3illing to
)a.
Kill is3illing to
)a.
$o,iet.5s@emandfor "arks
Marginal(ost
1 B B+ B B+2 B B BI B+
B2 B B+ B+ B1 B2 B B+
+ BD B1 B1 B+
!ssume:1- There are onl.
t3o )eo)le in
so,iet.-2- 7a,h additional
)ark ,osts B+
?o3 man. )arks
should #e made&
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% of"arks
!dam is3illing to
)a.
Kill is3illing to
)a.
$o,iet.5s@emand'M$>*
Marginal(ost )er
"ark
1 B B+ B B+2 B B BI B+
B2 B B+ B+ B1 B2 B B+
+ BD B1 B1 B+
@emand for a e3 "ark
Marginal 3illingness to )a. higher ta=es
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% of"arks
!dam is3illing to
)a.
Kill is3illing to
)a.
$o,iet.5s@emand'M$>*
Marginal$o,ial(ost
1 B B+ B B+2 B B BI B+
B2 B B+ B+ B1 B2 B B+
+ BD B1 B1 B+
@emand for a e3 "ark
Marginal 3illingness to )a. higher ta=es
)timalH amount
of a )u#li, good
is 3here
M$> 0 M$(J
$ l d @ d f " #li " k
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Price
Quantity of Parks
$ 9
7
5
3
1
0 1 2 3 4 5
D=MSB
$u))l. and @emand for "u#li, "arks
The @emand is
e9ual to the
marginal #enefit
to so,iet.
$ l d @ d f " #li " k
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$ 9
7
5
3
1
0 1 2 3 4 5
The su))l. is the
)u#li, good5s
marginal ,ost toso,iet.
S=MSC
D=MSB
$u))l. and @emand for "u#li, "arks
Price
Quantity of Parks
M$> 0 M$(
1- What if the government
made 1 )ark&
2- What if the governmentmade )arks&
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Market Failure %2:
7T7R!LT7$
33
Wh t 7 t liti &
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!n e=ternalit. is a third;)erson side effe,t-When there are 7T7R!L #enefits or ,osts to
someone T?7R than the original de,ision maker-
Wh. are 7=ternalities Market Failures&The free market fails to in,lude e=ternal ,osts or
e=ternal #enefits-With no government involvement4 there 3ould
#e too mu,h of some goods and too little of others-
7=am)le: $moking (igarettes-The free market assumes that the ,ost of smoking is
full. )aid #. )eo)le 3ho smoke-The government re,ognies e=ternal ,osts and makes
)oli,ies to limit smoking-
What are 7=ternalities&
34
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egative 7=ternalities
35
ti 7 t liti
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$ituation that results in a ($T for a different
)erson other than the original de,ision maker-
The ,osts s)ill overH to other )eo)le or so,iet.-7=am)le: Noram is a ,hemi,al ,om)an. that )ollutes
the air 3hen it )rodu,es its good-Noram onl. looks at its T7R!L ,osts-
The firm ignores the so,ial ,ost of )ollution
$o4 the firm5s marginal ,ost ,urve is its su))l. ,urve
When .ou fa,tor in 7T7R!L ,osts4 Noram is
)rodu,ing too mu,h of its )rodu,t-
The government re,ognies this and limits
)rodu,tion-
egative 7=ternalities'aka: $)illover (osts*
36
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8ideo; Whistle Ti)s
37
M k t f (i tt
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"
O
@0M$>
$u))l. 0
Marginal"rivate (ost
OFree Market 38
Market for (igarettesThe marginal )rivate ,ost doesn5t in,lude the
,osts to so,iet.-
M k t f (i tt
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"
O
@0M$>
$u))l. 0
Marginal"rivate (ost
OFree Market 39
Market for (igarettes
$u))l. 0Marginal
$o,ial (ost
What 3ill the M(/$u))l. look like 3hen 7T7R!L
,osts are fa,tored in&
O)timal
M k t f (i tt
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"
O
@0M$>
$0M"(
OFree Market 40
Market for (igarettes
$0M$(
O)timal
!t OFM the M$( is
greater than the M$>-Too mu,h is #eing
)rodu,ed
f the market )rodu,es OFM 3h. is it a market
failure&
verallo,ation
M k t f (i tt
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"
O
@0M$>
OFree Market 41
Market for (igarettesWhat should the government do to fi= a negative
e=ternalit.&
O)timal
$0M"(
$0M$(
$olution: Ta= the
amount of the
e=ternalit.
'"er Unit Ta=*
M k t f (i tt
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"
O
@0M$>
OFree Market 42
Market for (igarettesWhat should the government do to fi= a negative
e=ternalit.&
O)timal
$0M"(1
$0M$(
$olution: Ta= the
amount of the
e=ternalit.
'"er Unit Ta=*
0M"(2
M$> 0 M$(
$u))l. ,urve shifts left '.ello3*P
amount of ta= is the verti,al
distan,e #et3een M"(1 and M$(
'#la,k*
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43
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"ositive 7=ternalities
44
"ositive 7=ternalities
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"ositive 7=ternalities'aka: $)illover >enefits*
$ituations that result in a >77FT for someoneother than the original de,ision maker-
The #enefits s)ill overH to other )eo)le or so,iet.-'7: Flu 8a,,ines4 7du,ation4 ?ome Renovation*
7=am)le: ! mom de,ides to get a flu va,,ine forher ,hild
Mom onl. looks at the T7R!L #enefits-$he ignores the so,ial #enefits of a healthier so,iet.-
$o4 her )rivate marginal #enefit is her demandWhen .ou fa,tor in 7T7R!L #enefits4 themarginal #enefit and demand 3ould #e greater-
The government re,ognies this and su#sidies flushots- 45
Market for Flu $hots
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"
O
@0Marginal
"rivate >enefit
$ 0 M$(
OFree Market 46
Market for Flu $hotsThe marginal )rivate #enefit doesn5t in,lude
the additional #enefits to so,iet.-
Market for Flu $hots
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"
OOFM 47
Market for Flu $hotsWhat 3ill the M$>/@ look like 3hen
7T7R!L #enefits are fa,tored in&
O timal
@0Marginal
"rivate >enefit
$ 0 M$(
@0Marginal
$o,ial >enefit
Market for Flu $hots
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"
O
@0M$>
48
Market for Flu $hotsf the market )rodu,es OFM 3h. is it a market
failure&
$ 0 M$(
@0Marginal
$o,ial >enefit
OFM O timal
Market for Flu $hots
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"
O 49
Market for Flu $hots
Underallo,ation
$ 0 M$(
@0Marginal
$o,ial >enefit
OFM O timal
!t OFM the M$( is less than the M$>-
Too little is #eing )rodu,ed
Market for Flu $hots
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"
OOFM 50
Market for Flu $hots
O timal
@0M">
$ 0 M$(
@0M$>
What should the government do to address a
)ositive e=ternalit.&
$u#sidie the amount of the
e=ternalit. '"er Unit $u#sid.*
0M">
$u#sid. shifts M$>/@ right '.ello3*P
amount of su#sid. is verti,al distan,e
#et3een M> ,urves '#la,k*
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Revie31- What is an 7=ternalit.&
When 7T7R!L #enefits or e=ternal ,ostsare on someone other than the original de,isionmaker-
2- Wh. are 7=ternalities Market Failures&
The free market fails to in,lude e=ternal ,ostsor e=ternal #enefits-
- 7=)lain 3h. the gra)h for a egative7=ternalit. has t3o su))l. ,urves-T3o (osts: "rivate and $o,ial
- 7=)lain 3h. the gra)h for a "ositive7=ternalit. has t3o demand ,urves-
T3o >enefits: "rivate and $o,ial 51
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The 7,onomi,s of"ollution
52
7 i f " ll ti
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7,onomi,s of "ollutionWh. are )u#li, #athrooms so gross&
The Traged. of the (ommons'!Q!: The (ommon "ool "ro#lem*
Goods that are availa#le to ever.one 'air4
o,eans4 lakes4 )u#li, #athrooms* are often
)olluted #e,ause no one has the in,entive to
kee) them ,lean-
There is no monetar. in,entive to use them
effi,ientl.-Result is high s)illover ,osts-
7=am)le: ver fishing in the o,ean 53
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The (ommon "ool "ro#lem
54
"erverse n,entives
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"erverse n,entives
1- n 1ID4 the government tried to )rote,t endangered
3ood)e,kers #. re9uiring land develo)ers to re)ortnests on their land to the 7"!-The )o)ulation of these #irds de,reased- Wh.&
Land o3ners 3ould kill the #irds to avoid risk of length.)rodu,tion dela.s- 'Qno3n as $hoot4 $hovel4 and $hut U)H*
2- !ssume the government 3anted to limit a firm from)olluting- The. tell the firm it 3ill #e ins)e,ted t3i,eand it must redu,e )ollution #. +E-
The amount of )ollutants 3ould in,rease- Wh.&This firm 3ill have the in,entive to )ollute more )rior to
the initial ins)e,tion-
!re their market solutionsH to these
)ro#lems& 55
?o3 ,an markets and self interest hel) to
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?o3 ,an markets and self interest hel) tolimit )ollution&
Government ,an sell the right to )ollute
1DD
2DD
+D+D
1DD
!ssume the lake ,an
naturall. a#sor# +DD
gallons of )ollutants
ea,h .ear
o3 3hat does ea,h
firm have the in,entive
to do&
The Gov5t sells ea,h
firm the right to
)ollute a set num#er
of gallons
2D1D "ra,ti,e FRO
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57
2D1D "ra,ti,e FRO
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Market Failure %
Mono)olies
58
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Mono)ol. Revie31- @ra3 a mono)ol. making a )rofit- La#el
)ri,e and out)ut4 and shade 'or la#el*
)rofit-
2- dentif. three s)e,ifi, reasons 3h.
mono)olies are #ad-
- La#el the Fair Return )ri,e and out)ut-
- La#el the $o,iall. )timal )ri,e andout)ut-
+- 7=)lain 3h. ta=ing a mono)ol. is a #ad
idea- 59
Mono)ol.
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D
M
$9
!
7
"
5
43
2
MC#C
601 2 3 4 5 " 7 ! 9 10 O
"
Profit =$5
Unregulated $o,iall.)timal
Fair
Return
Mono)ol.
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Government in !,tion:
!ntitrust La3s
Legislative 7=e,utive Kudi,ial
61
W?!T !R7 !TTRU$T L!W$&
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W?!T !R7 !TTRU$T L!W$&La3s designed to )revent mono)olies and
)romote ,om)etition-
!fter the (ivil War4 advan,es in te,hnolog. and
trans)ortation led to national markets-
7ventuall. onl. a fe3 firms #egan to dominate
industries: railroads4 steel4 meat)a,king4 ,oal4 et,-
Wh. are mono)olies a Market Failure&
Mono)olies destro. the ke. ingredient of the free
market s.stem (om)etition-
To fi= this M!RQ7T F!LUR74 the government must
get involved-
62
W?!T @7$ T?7 G87RM7T @&
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W?!T @7$ T?7 G87RM7T @&Legislative >ran,h
"assed la3s designed to sto) mono)olies
$herman !,t of 1CD;Every person who shall monopolize or conspire to
monopolizeshall be deemed guilty of a felony.
7=e,utive >ran,hThe Federal Trade (ommission must a))rove all
,or)orate mergers- 'Like !TST and A*
When firms use anti;,om)etitive ta,ti,s the
@e)artment of Kusti,e files suit against them-
Kudi,ial >ran,h
The ,ourts find the firm guilt. or not guilt. and assign
a )unishment- 63
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64
Revie3
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Revie31- @efine Market Failure-2- dentif. the four market failures 3e have
learned in this unit-- 7=)lain 3h. are )u#li, goods a market failure-- 7=)lain 3h. are e=ternalities a market failure-+- 7=)lain 3h. are mono)olies a market failure-
6- >. .ourself4 dra3 a )ositive e=ternalit.-
I- >. .ourself4 dra3 a negative e=ternalit.-
C- Use gra)h to e=)lain the remed. for )ositive
e=ternalities-- Use gra)h to e=)lain the remed. for negative
e=ternalities-
1D-ame 1D different su)er heroes- 65
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Market Failure %
Unfair @istri#ution
of Wealth
66
Net Worth
over $2.3
billion
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1- What )er,ent of !meri,ans are living in
)overt.&
2- Wh. is in,ome distri#ution a market failure&67
n,ome ne9ualit.
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n,ome ne9ualit.n 2DD4 the average !meri,an famil. made
B664C6- 7ver.one is o#viousl. ri,h-What5s 3rong 3ith using the average&
!verages reveal a#solutel. nothing a#out ho3
in,ome is distri#uted-
?o3 does the government
measure distri#ution of in,ome&$MUL!T
'>ased on 2DD nformation* 68
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T?7 LR7N(UR87
$MUL!T
69
Measuring n,ome @istri#ution
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Measuring n,ome @istri#utionRevie3 the )ro,ess:
The government divides all in,ome earningfamilies into five e9ual grou)s 'quintiles* from
)oorest to ri,hest-
7a,h grou)s re)resents 2DE of the )o)ulation- f there 3as )erfe,t e9ualit. then 2DE of the
families should earn 2DE of the in,ome4 DE
should earn DE 'and so on*-
The government ,om)ares ho3 far the a,tual
distri#ution is from )erfe,t distri#ution then
attem)ts to redistri#ute mone. fairl.-
70
Measuring n,ome @istri#ution
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Measuring n,ome @istri#ution$ummar.:
Grou) %1 '"oorest 2DE* Total of B+ '+E of total in,ome*
Grou) %2
Total of B1D '1DE of total in,ome*Grou) %
Total of B1+ '1+E of total in,ome*
Grou) %
Total of B2+ '2+E of total in,ome*
Grou) %+ 'Ri,hest 2DE*
Total of B6+ '+E of total in,ome*
71
The Loren (urve
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2D D 6D CD 1DD
1DD
CD
6D
D
2D
D
"er,ent of Families
"er,entof1n,ome
"erfe,t 79ualit.
The Loren (urve
72
The Loren (urve
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2D D 6D CD 1DD
1DD
CD
6D
++
D
D
2D
1+
+
D
"er,ent of Families
"er,entof1n,ome
"erfe,t 79ualit.
Loren (urve
'a,tual distri#ution*
73
The Loren (urve
The Loren (urve
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2D D 6D CD 1DD
1DD
CD
6D
++
D
D
2D
1+
+
D
"er,ent of Families
"er,entof1n,ome
"erfe,t 79ualit.
Loren (urve
'a,tual distri#ution*
74
The Loren (urve
The sie of the
#anana sho3sthe degree of
in,ome ine9ualit.-
The Loren (urve
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2D D 6D CD 1DD
1DD
CD
6D
++
D
D
2D
1+
+
D
"er,ent of Families
"er,entof1n,ome
"erfe,t 79ualit.
!fter @istri#ution
75
The Loren (urve
The #anana gets
smaller 3hen thegovernment re;
distri#utes in,ome
Welfare )rovides a safet. net for ,itiens
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'retirement4 unem)lo.ment4 3orkers ,om)4 health4 et,-*
>UT4 3hat are some )ossi#le do3nsides&
Where does the government get
the mone. for 3elfare&
76
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Ta=es
77
What are Ta=es&
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What are Ta=es&
Wh. does the government ta=&
T3o )ur)oses:
1- Finan,e government o)erations- "u#li, goods high3a.s4 defense4 em)lo.ee
3ages
Fund "rograms 3elfare4 so,ial se,urit.
2- nfluen,e e,onomi, #ehavior of firms and
individuals- 7=: 7=,ise ta= on to#a,,o raises ta= revenue and
dis,ourages the use of ,igarettes-
Ta=es mandator. )a.ments made to the
government to ,over ,osts of governing-
78
Three T.)es of Ta=es
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Three T.)es of Ta=es1- "rogressive Ta=es ;takes a larger)er,entage of
in,ome from high in,ome grou)s 'takesdollars at in,reasing rate from ri,her )eo)le*-
7=: (urrent Federal n,ome Ta= s.stem
- Regressive Ta=es takes a larger)er,entage
from lo3 in,ome grou)s 'takes more from )oor
)eo)le*-
7=: $ales ta=P an. ,onsum)tion ta=-
2-"ro)ortional Ta=es 'flat rate*takes the same
)er,ent of in,ome from all in,ome grou)s-
7=: 2DE flat in,ome ta= on all in,ome grou)s
79
Three T.)es of Ta=es
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What kind of ta=es are these&
'T?Q E of n,ome*
1- Toll road ta= 'B1 )er da.*
2- $tate in,ome ta= 3here ri,her ,itiens )a.higher E
- B-+ ta= on ,igarettes
- Medi,are ta= of 1E of ever. dollar earned+- C-2+E (alifornia sales ta=
80
Three T.)es of Ta=es
Federal n,ome Ta= @e#ateFederal n,ome Ta= @e#ate
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Federal n,ome Ta= @e#ateFederal n,ome Ta= @e#ateEqual Tax of $350 per week (Regressive Tax)Equal Tax of $350 per week (Regressive Tax) Income Amount of Tax % Amount to live on
$200 $350 175% -$150)[crime?] $350 $350 100% $0 $500 $350 70% $150 $1,000 $350 35% $650
$5,000 $350 7% $,650
!la" "ax of 20# per week (ropor"io%al Tax)!la" "ax of 20# per week (ropor"io%al Tax) Income Amount of Tax Amount to live on
$200 $0 $160
$350 $&0 $2'0 $500 $100 $00 $1,000 $200 $'00 $5,000 $1,000 $,000
81
Federal n,ome Ta= @e#ateFederal n,ome Ta= @e#ate
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Federal n,ome Ta= @e#ateFederal n,ome Ta= @e#ate
This is our ,urrent s.stem- s it fair&
The )rogressive ta= s.stem is the most
effe,tive 3a. to fight this market
failure
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The Laffer (urve
$ho3s relationshi) #et3een ta= rate
and ta= revenue-
What 3ould ha))en if the highest ta=#ra,ket 3as I+E&
83
The L!$T mi,ro gra)h to
learnJJJJ
T?Q R> ?@JJJJJJ
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What 3as his grou)5s name&Merr. Men
What did the. do&Laugh a lot A the. 3ere Laffers-H
What 3as his 3ea)on of ,hoi,e&>o3 and !rro3
What did Ro#in ?ood do&$teal from the ri,h and give to the )oor-
What 3ould ha))en to the amount of travelers
through $her3ood Forest if he took +Einstead of E of their mone.&
What 3ould ha))en to the total amount of
mone. he ,olle,ts& 84
The Laffer (urve
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The Laffer (urve
85
E Ta=
Rate
Ta= Revenue
f the government
in,rease ta=es ratesta= revenue 3ill
in,rease
f the ta= rate#e,omes too high4 ta=
revenue 3ill fall sin,e
3orkers have no
in,entive to 3ork
harder
GR7!T 7W$
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GR7!T 7W$A
U !R7 @7 WT?M(RJJJJ
86
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"ra,ti,e FROs
87
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882005, #2
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