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The U.S Economy: Private and Public Sectors Chapter 4 (Mc Connell and Brue) Announcements • Quiz on Sunday 14th Feb • Presentation Group 1 on Friday 19th Feb Chapter Objectives • Important facts about U.S households and U.S businesses • The problem that arises when corporate owners and their managers have different interests • Economic Role of government in the economy • Categories of government spending and sources of government revenues Households as Income Receivers • • • • 113 Million households in US Act as suppliers of economic resources Major spenders in the economy Income received by households can be categorized into how it is earned and how it is divided Functional Distribution of Income Indicates how the nations earned income is apportioned among: • Wages • Rents • Interest • Profits Functional Distribution of Income-2005 Income By Function Performed 0 Wages & Salaries Rents Interest Proprietor’s Income Corporate Profits National Income Received (Percent) 10 20 30 40 50 60 70 71% 1% 5% 9% 14% Source: Bureau of Economic Analysis Personal Distribution of Income-2004 • Indicates how nation’s money income is divided amongst individual households 0 Income Group (Households) Lowest 20% Second 20% Middle 20% Fourth 20% Highest 20% Personal Income Received (Percent) 10 20 30 40 50 60 3.4% 8.7% 14.7% 23.2% 50.1% Source: Bureau of the Census Households as spenders • Personal Taxes: Personal Income tax takes up the largest component of personal taxes. (12%) • Personal Savings: -Saving is that part of after tax income that is not spent (bank accounts, mutual funds) • Reasons for saving: -Security and speculation • Dis-saving • Personal consumption expenditure (88%) Households as Spenders Household Uses of Income-2005 0 Household Income Expended (Percent) 10 20 30 40 50 60 70 80 90 Income Group (Households) Personal Taxes Personal Saving 12% 0% Personal Consumption 88% Consumption Divided Between… Composition of Consumption 59% 29% 12% Services Nondurable Goods Durable Goods Source: Bureau of Economic Analysis Review • • • • Functional Distribution Personal Distribution Saving Consumer Spending The Business Population • Plant: physical establishment that performs one or more functions in fabricating and distributing goods and services • Firm: Business organization that owns and operates the plant • Industry: Group of firms that produce the same, or similar, products Types of firms • Multi-plant firms: Several plants performing the same function • Vertically integrated: Own plants that perform different functions in various stages of the production process • Conglomerates: Plants that produce products in several industries Legal Forms of Businesses • Sole proprietorship: owned and operated by one person • Partnership: 2 or more individuals agree to own and operate a business together • Corporation: Legal creation that can acquire resources, produce and sell products, incur debts etc. (distinct and separate from individual stockholders) Legal Forms of Business Domestic Output by Business Type 20% Corporations 8% Partnerships 72% Corporations 84% Partnerships 11% Sole Proprietorships Sole Proprietorships Percentage of Firms 5% Percentage of Sales Source: U. S. Census Bureau Advantages of Corporations • Most effective form of business to raise capital • Common Stock: Share in ownership and dividends declared • Corporate bond: No ownership , pays the holder a fixed amount (example of a bond) • Why do individuals invest in corporations? • Limited Liability • Easily expand scope of activities and benefit • Permanence: Long range planning & growth The Principal-Agent Problem • Sole proprietorship and partnerships: owners have direct control over the assets • Corporations hire managers • Principals : Stockholders • Agents: Managers • Conflict: Maximum profits and Stock price vs power , prestige, pay Review • • • • Plant, firm and industry Legal forms of business Advantages of corporations Principal –agent problem The Public Sector: Governments Role • Providing the Legal Structure -Legal framework and services for a market economy to operate efficiently -Rights of property ownership , making and enforcement of contracts -Increase volume and safety of exchange : better allocation and specialization of resources -MC and MB of intervention The Public Sector: Governments Role • Maintaining Competition -Essential for market system ( consumer sovereignty) -Monopoly: Charge higher than competitive price -Natural Monopolies: Single Seller can achieve lowest possible costs -Antitrust laws The Public Sector: Governments Role • Redistributing Income -Market system redistributes income inequitably -Methods of redistribution: -Transfer payments -Market intervention -Taxation -Benefits and costs The Public Sector: Governments Role • Reallocating Resources -A market failure occurs when the market: a)Produces wrong amounts of certain goods b)fails to allocate resources to production of certain goods -Externalities: Occur when some of the cost or benefit of a good are passed onto someone other than the buyer or seller The Public Sector: Governments Role • Negative Externalities : Production or consumption costs inflicted on third party without compensation -over allocation of resources (supply) • Solution: internalize cost -Legislation : forces offenders to bear cost -Specific taxes: Tax confined to a particular product The Public Sector: Governments Role • Positive Externalities: benefits to other producers or consumers (examples) -Demand curve lies farther to left than it would if all benefits accounted for -Too little produced, under allocation -Solutions: a)Subsidize consumers b)Subsidize producers c)Provision of goods via government (usually when externality is large) The Public Sector: Governments Role • Public Goods and Services -Private goods produced through market system (rivalry and excludability) -Public goods a)Non rivalry: everyone can simultaneously benefit b)Non excludabaility : one persons benefit does not reduce benefit available to others The Public Sector: Governments Role • Free Rider Problem: benefit without contributing to cost -Government provides for these goods and finances through taxation • Quasi Public Goods : Goods and services that can be produced and delivered in a way that exclusion is possible e.g. Highways • Reallocation process:Taxation to reduce demand and free up resources for production of public goods The Public Sector: Governments Role • Promoting Stability – Unemployment: Can occur when private spending is too low. Government can increase government spending or reduce taxes – Inflation: Spenders try to buy more than economy’s capacity. Government can decrease government spending or increase taxes Review • Ways of redistribution • Negative and positive externality • Public goods The Circular Flow Resource Market Expenditures Resources Goods & Services Businesses Goods & Services Government Net Taxes Households Net Taxes Goods & Services Expenditures Product Market Government Finance • Government Purchases are exhaustive: products purchased directly absorb resources and are part of domestic output • Transfer payments are not exhaustive: Recipients make no current contribution to domestic output Government Finance 35 Percentage of U.S. Output 30 27% 25 Government Transfer Payments 31% 5% 12% 22% 19% 20 15 10 Government Purchases 5 0 1960 2005 Government Finance GLOBAL PERSPECTIVE Total Tax Revenue – Selected Nations Percent of Total Output-2004 10 Sweden Denmark Norway Finland France Italy United Kingdom Germany Canada Australia United States Japan South Korea 20 30 40 50 50.7 49.6 44.9 44.3 43.7 42.2 36.1 34.6 33.0 31.6 25.4 25.3 24.6 Source: Organization for Economic Cooperation and Development Federal Finance Federal Expenditures-2005 Four Stand-Out Areas of Spending 0 10 20 30 Pensions & Income Security 50 35% National Defense 20% 17% Health Interest on the Public Debt 40 7% Source: U. S. Office of Management and Budget Federal Tax Revenues-2005 Basic Revenue Sources 0 10 20 Personal Income Tax 50 37% Corporate Income Taxes All Other 40 43% Payroll Taxes Excise Taxes 30 13% 3% 4% Source: U. S. Office of Management and Budget Personal Income Tax • Taxable income (exemptions and deductions) • Progressive tax : higher percentage of income paid • Marginal Tax rate: Tax paid on each additional unit of taxable income • Average tax rate : Tax paid /Taxable income Example Total Taxable Income ($) Marginal Tax Rate Total Tax on highest Average Tax Rate income in bracket on highest income in bracket 1-15,100 10.0 1510 10 15,101-61,300 15.0 8440 13.8 61,300-123,700 25.0 24,040 19.4 123,700-188,450 28.0 42,170 22.4 188,450-336,550 33.0 91,043 27.1 Over 336,500 35.0 Other forms • Payroll Taxes: Social Security contributions • Corporate Taxes: Levied on corporations profit • Excise Taxes: Tax on commodities and purchases • State finances : Sales and excise tax, spent on education and welfare etc • Local finances : Property taxes