Tabl. 2. Government Spending as a Percentage of National Income

In each case, we look atfour measures of government spending as a percentage of national income: spending on the direct provision of goods and services for the public, transfer payments, Interest on the national debt, and total spending.

Italy is a "big-government" country. Its government spending is large and it needs to raise correspondingly large tax revenues. In contrast, Japan has a much smaller government sector and needs to raise correspondingly less tax revenue. These differences in the scale of government activity relative to national income reflect differences in the way different countries allocate their resources among competing uses.

Governments spend part of their revenue on particular goods and services such as tanks, schools and public safety. They directly affectwhat is produced. Japan's low share of government spending on goods and services in Tabl. 2 reflects the very low level of Japanese spending on defence.

Governments affectfor whom output is produced through their tax and transfer payments. By taxing the rich and making transfers to the poor, the government ensures that the poor are allocated more of what is produced than would otherwise be the case; and the rich get correspondingly less.

The government also affecthow goods are produced, for example through the regulations it imposes. Managers of factories and mines must obey safely requirements even where these are costly to implement, firms are prevented from freely polluting the atmosphere and rivers, offices and factories are banned in attractive residential parts of the city.

The scale of government activities in the modem economy is highly controversial. In the UK the government takes nearly 40 per cent of national income in taxes. Some governments take a larger share, others a smaller share. Different shares will certainly affect the questionswhat, how and for whom, but some people believe that a large government sector makes the economy inefficient, reducing the number of goods that can be produced and eventually allocated to consumers.

It's commonly asserted that high tax rates reduce the incentive to work. If half of all we earn goes to the government, we might prefer to work fewer hours a week and spend more time in the garden or watching TV. That is one possibility, but there is another one: if workers have in mind a target after-tax income, e.g. to have at least sufficient to afford a foreign holiday every year, they will have to work more hours to meet this target when taxes are higher.

Whether on balance high taxes make people work more or less remains an open question. Welfare payments and unemployment benefit arc more likely to reduce incentives to work since they actually contribute to target income. If large-scale government activity leads to important disincentive effects, government activity will affect not only what, how, and for whom goods are produced, but also howmuch is produced by the economy as a whole.

This discussion of the role of the government is central to the process by which society allocates its scarce resources. It also raises a question. Is it inevitable that the government plays a prominent part in the process by which society decides how to allocate resources between competing demands? This question lies at the heart of economics.

THE PRODUCTION POSSIBILITY FRONTIER

Let's turn to the most important tool for an economist – the production possibility frontier. This frontier shows the maximum combinations of output that the economy can produce, if it uses all its available scarce resources.

The easiest way to explain it is to complete a figure. First, the vertical axis or line, is labelled "food output". The units of food output run from nought at the bottom to 25 at the top, entering the units of food output in fives: 0, 5, 10, etc. Along the horizontal axis (or the bottom line) we have units of film output. Let's enter in the units of film output in fives again, this time up to 30.

Suppose we have an economy with only food and film industries. Now, if we put all the workers into producing food, we shall produce 25 units of food, but no units of film. We can mark this on the diagram with point A – no film, 25 units of food. It means point A comes on the vertical line at the number 25. Now, at the other extreme, if the economy puts all its workers into producing film, it will produce 30 units, but it will not produce any food. So, the next point is on the bottom, horizontal line, at 30 units. Let's label it as point E.

These two points, A and E, arc the two extreme points of the production possibility frontier. Let's put in three more points. Point В is where the economy is producing 22 units of food and 9 units of film. Point С is where the economy is producing 17 points of both film and food. And, finally, point D is where we have 10 units of food and 24 units of film. Now draw a line joining all these points together, from A to E. The line drawn is not a straight line, it's a concave curve. It is this concave curve that is called the production possibility frontier.

The production possibility frontier represents a trade-off. More of one commodity, food or film, means less of the other, and this is because of the law of diminishing returns. It states that if, in the production of a commodity, one factor of production is increased by stages while the other factors are kept unchanged, the stage will sooner or later be reached where each farther addition to the increasing factor will produce a smaller and smaller increase in output.

In our example, movements from A toB, to С and so on along the curve involve the transfer of one or more workers from one industry to the other, say, from food production to film production. The number of workers in the film industry increases, and so does the film output, but on the whole each additional worker produces less additional film. That is to say, each transfer reduces output per person in the film industry. At the same time a decrease in the food industry can be observed. So with each transfer we get less additional film output and have to give up increasing amounts of output. That's why a society faces the problem of choosing between different products, as the scarcity of available resources does not allow it to increase the production of one good without decreasing the production of the other. As all the resources are scarce, points outside the frontier (point F in the example) represent the level of production unattainable at the given stage of development. On the contrary, it is inefficient to produce within the frontier (point G in the example), as it means poor management of production. By moving on to the frontier, society could have more of some goods without having less of any other good.

ECONOMIC SYSTEMS

There are a number of ways in which a government can organize its economy and the type of system chosen is critical in shaping environment in which businesses operate.

An economic system is quite simply the way in which a country uses its available resources (land, workers, natural resources, machinery etc.) to satisfy the demands of its inhabitants for goods and services. The more goods and services that can be produced from these limited resources, the higher the standard of living enjoyed by the country's citizens.

There are three main economic systems:

Planned economics (Плановая экономика)

Planned economies are sometimes called "command economies" because the state commands the use of resources (such as labour and factories) that are used to produce goods and services as it owns factories, land and natural resources. Planned economies are economies with a large amount of central planning and direction, when the government takes all the decisions, the government decides production and consumption. Planning of this kind is obviously very difficult, very complicated to do, and the result is that there is no society, which is completely a command economy. The actual system employed varies from state to state, but command or planned economies have a number of common features.

Firstly, the state decides precisely what the nation is to produce. It usually plans five years ahead. It is the intention of the planners that there should be enough goods and services for all.

Secondly, industries are asked to comply -with these plans and each industry and factory is set a production target to meet. If each factory and farm meets its target, then the state will meet its targets as set out in the five-year plans. You could think of the factory and farm targets to be objectives which, if met, allow the nation's overall aim to be reached.

A planned economy is simple to understand but not simple to operate. It does, however, have a number ofadvantages: