Chapter Study Outline


Government action makes the market economy possible. America’s huge free-market economy and its participation in an increasingly global economy depend heavily on government policies. Public policy is an officially expressed intention backed by a sanction (either a reward or a punishment). In that public policies are critically important to ordering the economy, political actors seek to manipulate and change those policies, but changes are infrequent and hard won.

1. How Does Government Make a Market Economy Possible?

How do governmental actions protect and promote a healthy economy? Why does the government get involved in the market?

  • Although some think of the market economy as the natural order of things, governments must exist to provide the prerequisites for a market economy, including establishing law and order; defining the rules of property and its exchange; enforcing contracts; setting market standards; providing public goods and ameliorating externalities; creating a labor force; and promoting competition.
    • By establishing law and order, government provides the minimal degree of predictability necessary for all social interaction, including economic activity.
    • By defining the rules of property, government protects the incentives individuals have to create, produce, and accumulate wealth. Once it has defined and protected property rights, the government also sets the conditions under which property can be transferred from one citizen to another.
    • Governments also enforce contracts to protect property rights.
    • Governments also set market standards by regulating and defining weights, measures, and definitions that facilitate exchanges on a mass level.
    • When the market fails to provide something that is nevertheless valuable to a society or community, the government may provide such public goods. Historically, government efforts to improve transportation have been particularly important to promoting economic development. Government policies also exist to ameliorate externalities (that is, to minimize or regulate the negative, sometimes unintended, consequences of market-oriented behavior).
    • Governments also create a labor force that is skilled and educated.
    • Finally, to avoid markets’ tendencies toward monopoly, government policies aim to promote and maintain market competition.
  • Governments are deeply embedded in the operation of a market economy to overcome market failures, which can occur due to incomplete information, bubbles driven by speculative buying, insecure property rights, and externalities.

2. The Goals of Economic Policy

What are the goals of economic policy? How does the government accomplish its multiple economic aims?

  • Government intervenes in the economy to protect the welfare and property of individuals and businesses by promoting stable markets. It does so, first, by maintaining law and order but also by regulating competition and providing public goods.
  • Governments also engage in economic policy in overall efforts to promote economic prosperity. Carefully tracking economic growth and related indicators, the government promotes investment by increasing business, investor, and consumer confidence and by supplying the tools necessary for successful commerce, including capital, research for innovation, and an adequate supply of labor.
  • The national government also promotes business development.
    • During the nineteenth century, government tariff policies and government investment in the railroads created and promoted markets throughout America; similar subsidies continue today for all manner of businesses, including agriculture.
    • In the twentieth and twenty-first centuries, the national government began to employ categorical grants-in-aid to promote behaviors that it deemed desirable.
  • Another area of government economic policy is the protection of employees and consumers through policies such as the minimum wage and creation of the Consumer Product Safety Commission, respectively.

3. The Tools of Economic Policy

How does the government accomplish its economic aims? What are the various tools and instruments the government uses to maintain and promote the market economy?

  • The U.S. economy is the result of specific policies that have expanded American markets and sustained massive economic growth over time.
  • Monetary policies manipulate the growth of the entire economy by controlling the availability of money and credit; the autonomy of the Federal Reserve System allows it to stimulate or put a brake on the economy, particularly through the setting of interest rates. The Fed also controls the reserve requirement of banks and conducts open-market operations that affect the supply of money in the economy.
  • Fiscal policies include government’s taxing and spending powers and can similarly have broad effects on the macroeconomy.
    • Tax policies, central to the government’s fiscal policies, discriminate, hitting some people harder than others; progressive taxes require the wealthier segments of society to pay higher tax rates, whereas regressive taxes are those that fall disproportionately on those in lower income brackets.
    • The federal government’s power to spend is one of the most important tools of economic policy.
  • The president and the Congress both play important roles shaping economic policy, although an increasing portion of federal spending is mandatory or “uncontrollable” spending that the government owes to citizens.
  • In addition to promoting behavior, some economic policies also seek to regulate undesirable behaviors.
    • Mistrusting monopoly, governments regulate markets to promote fair competition and even employ antitrust policies to break up large businesses that are a threat to the market.
    • Administrative regulations, the rules made by regulatory agencies and commissions, seek to control the conduct of private actors in society and the economy; the politics of regulatory policy tends to be dominated by interest groups.
  • Subsidies and contracts are key tools used by the government to promote desirable behaviors in the marketplace.

4. The Environment and the Economy

How does the increased interest in environmental policy affect the American economy? What approaches does the government employ in its efforts to balance environmental aims and economic aims?

  • Stretching back to the early 1900s, the national government’s interest in preserving the environment nevertheless has increased significantly since the 1970s.
  • The conflicts between environmentalism and economic interests are most pronounced in the current debate over global warming.

5. The Politics of Economic Policy Making

How have America’s political leaders transformed the public’s expectations regarding the appropriate role of government in the economy? How have these expectations changed over time?

  • Traditionally, Americans believed that the government should only play a limited role in the economy.
  • After the Great Depression, however, Franklin Roosevelt transformed public expectations of the government’s economic role.
  • Now, government involvement in the economy is routine, widespread, and expected, and politicians’ successes and failures are subject to the overall state of the economy and their ability to curry favor with economically oriented interest groups.