GED Social Studies Practice Test: The Role of the Government in the Economy

Since we don’t live in a laissez-faire capitalist economy (but rather a capitalist-oriented mixed economy). The federal government employs about 4.3 million people. Add in state and local government employees (everyone from a mayor to a dog catcher), and you come up with a figure greater than 20 million.

Of course, not everyone working for a government is involved in an aspect of economic management. But when you figure in the wages (and the value of the benefits) paid to government workers constitute about 16% of the GDP of the United States (according to the World Bank).  That may seem very high to you, but, remember, we’re a nation of almost 315 million people. Someone has got to do the job.

In 2011, the U.S. government spent 3.6 trillion. Most of that was on non-discretionary spending such as interest on the national debt (the amount of money the government owes to creditors), and programs such as Medicare and Social Security. Only a small part is non-discretionary (such as research grants, foreign aid, and defense spending). Since the government is spending more than it takes in (and has to issue bonds and borrow money), it runs a deficit (outlay > revenues). Where does the government get the money to spend? Taxes and fees, of course! In 2011, the federal government took in about $1 trillion in income taxes (7.5% of the GDP), according to the Congressional Budget Office, and $819 billion in Social Security taxes from employers. Corporate taxes (5.5% of the GDP) accounted for $819 billion, while $211 billion was received through fees, tariffs, and miscellaneous expenses.

Keep in mind it’s expensive to run the government. Air-traffic controllers and meat inspectors must be paid. The government runs an immense defense establishment (and soldiers, sailors, and airmen must be paid, fed, and housed). Want clean water? Then the Environmental Protection Agency must be funded. Want workplace safety rules, then you have to spend money on the Occupational Health and Safety Administration.

The Most Powerful of the Powerful: The Federal Reserve

Banking before the 1900s was a chaotic affair. Most banks were licensed by the states, and there were few regulations. Many banks did not keep enough deposits on hand, and as soon as economic turmoil hit, people would make a “run” on the banks. Since the banks had loaned out substantial sums, they didn’t have money on hand to satisfy their depositors’ demands. Often, depositors walked away empty-handed, and there was no way of redressing the situation.

In 1913, as part of the Progressive Era reforms under President Woodrow Wilson, the Federal Reserve System was created. It serves as the nation’s central bank and regulator of the commercial banking system of the U.S. It also sets policies that have a tremendous (some might say too tremendous) impact on the American economy.

So what, exactly, does “the Fed” do? First off, it supervises the 3,000 or so federally-chartered banks that belong to it (there are over 8,000 banking institutions in the U.S., and most are small organizations that do not belong to the Fed.

Second, it maintains the stability of the economic system by holding cash reserves (money belonging to the U.S.) and releasing it when needed.

Third, it helps moves money in and out of circulation, which can help to control inflation. In short, the Fed creates and implements the monetary policy of the U.S. The less money there is in circulation, the greater its value, and the lower the inflation rate. When money is released into the money supply, inflation goes up. These tools can be useful in helping to regulate the economy.

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A Quick Look at Savings and Investing

A savings account at a bank or similar institution is likely to be a very safe investment, but in return for such safety, you will get very low (maybe 1% or 2%) interest. Banks an savings institutions take the money they receive from depositors and then make loans. But your deposit, as you may recall from your reading about the Great Depression, is insured by the Federal Deposit Insurance Corporation, a government agency that protects the money you have in the bank.

It you want to try to make more money from the money you have to invest, you may wish to consider buying stock. Stock is fractional ownership. Let’s say the XYZ Corporation issues 100 shares of stock at $10 per share. You buy 10 shares. This means you now own 10% of the company. Shares are bought and sold on stock exchanges (such as the New York Stock Exchange).

But stock offers no guarantees. If the company performs well and has a profit (total revenues minus all operating expenses), it may pay a dividend. Let’s say the XYZ Corporation has a profit of $1000 and decides to put $500 of that money toward dividends (it will keep the rest in its cash reserves). That means there will be a $5 dividend on each share of stock, and your original $100 investment is now work $150 ($10 x 10 shares + $5 per share x 10). Pretty good, huh?

But the downside is that if the company performs poorly and loses money, the value of your stock may go down. With stock, there’s no guarantee you’ll make money. If you have no tolerance for risk, then stocks are not for you.

A safer investment is a bond. A bond is nothing more than an I.O.U. When a company issues a 10-year bond with a 5% interest rate, you invest $100 now and get $105 in one decade. Bonds are very safe investment. To raise money, the U.S. Treasury issues bonds, usually with a term of six months to one year. Of course, in inflationary times, a company must offer a higher interest rate in order to attract investors. There is one downside: if the company goes out of business, it’s possible you’ll be left holding a worthless piece of paper. But most bonds are safe investments.

If you want even more security, you may want to consider investing in mutual funds, which are collections of stocks put together by investment companies. When you buy a share of a mutual fund, you might own bits of many different companies. Since there is a variety of investments in the mutual fund, things tend to even out, and most mutual funds are safe. There are all types of mutual funds; some invest only in the safest stocks and companies, others may trade in medium risk, and yet others may buy high-risk investments. As a rule, the more risk you take, the greater the possibility of high returns. But you may get burned. Many people are content to earn a bit less but have more security.


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