What Economies Do Chapter 3 © Dünhaupt, Dullien, Goodwin, Harris, Nelson, Roach, Torras

Introducing the Four Essential Economic Activities Chapter outline Introducing the Four Essential Economic Activities Resource Maintenance: Attending to the Asset Base of the Macroeconomy Distribution: Who Gets What, and How? Chapter 3

Learning goals After today’s lecture, you will be able to: Define the four essential economic activities. Define the five types of capital. Explain the difference between stocks and flows. Discuss the limitations of substitutability with respect to natural capital. Understand the importance of maintaining capital stocks. Describe the difference between exchange and transfer. Define the difference between wealth and income. Describe the distribution of income and wealth in the European Union. Describe how inequality is measured. Describe the three spheres of economic activity. Chapter 3

Introducing the Four Essential Economic Activities

The four essential economic activities resource maintenance: The management of capital stocks so that their productivity is sustained or improved production: The conversion of resources to goods and services distribution: The allocation of products and resources among people consumption: The final use of a good and service to satisfy current wants Chapter 3

Resource maintenance definition: “The management of capital stocks so that their productivity is sustained or improved” capital stocks: natural capital: physical assets provided by nature manufactured capital: physical assets generated by human productive activities to natural capital human capital: People’s capacity for work and their individual knowledge and skills social capital: Institutions and trust that facilitates social coordination of economic activity financial capital: Funds of purchasing power Chapter 3

Production production: Conversion of resources to goods and services goods: tangible objects that are produced for human use services: intangibles that are produced by one individual or organization, and offered to others manufactured assets: goods that are produced for investment purposes, to assist in the production of other goods and services inputs: resources that go into production outputs: the results of production waste products: outputs that are not used either for consumption or in a further production process Chapter 3

Figure 3.1: The role of financial capital in commercial production Chapter 3

distribution: the allocation of products and resources among people can take place through exchange or transfer exchange: trading one thing for another transfer: the giving of something with nothing specific expected in return Chapter 3

saving: Refraining from consumption in the current period consumption: The final use of a good or service to satisfy current wants sometimes, good is physically „consumed“ eating a meal burning gasoline in your car sometimes, consumption does not exclude the enjoyment of others looking at art in a museum saving: Refraining from consumption in the current period Chapter 3

Resource Maintenance: Attending to the Asset Base of the Macroeconomy

Figure 3.2 The general stock-flow diagram Starting from an initial quantity of a stock, flows into and out of the stock determine how great the quantity is the next time the stock is measured. Flows Stock Additions Time Subtractions Initial Next Chapter 3

Figure 3.3 “Bathtub”-style diagram Like water flowing into a bathtub, flows that add to a stock will tend to raise its level over time. Like water flowing out of a bathtub, flows that subtract from a stock will tend to lower its level over time. Additions or Inflows Subtractions or Outflows Stock Chapter 3

Investment and depreciation investment: Adding to the capital stock buying computers for an office (manufactured capital) planting trees (natural capital) depreciation or disinvestment: Decrease in the quantity or quality of capital stock gross investment: All flows into the capital stock over a period of time net investment: gross investment minus depreciation Chapter 3

Renewable resources, nonrenewable resources, and sustainability renewable resource: regenerates itself through biological or other short-term processes nonrenewable resources: have a fixed supply substitutability: the possibility of using one resource instead of another sustainable socioeconomic system: a system in which the overall quality and quantity of the resource base required for sustaining life and well-being do not erode Chapter 3

Distribution: Who Gets What, and How?

Labor and capital incomes In product and labor markets, exchanges typically involve a flow of goods or services from seller to buyer in return for a monetary payment the monetary payments create flows of labor and capital income labor income: compensation received by workers in the form of wages, salaries, and fringe benefits capital income: includes rents, profits and interest (“rent” refers to payments for the use of any capital asset) Chapter 3

Transfers transfers from the government are often made is response to people’s dependence needs social insurance programs include the federal Social Security and Medicare programs.   means-tested programs programs designed to transfer income to recipients based on need Chapter 3

a regressive tax: applies a higher tax rate to poorer households Taxes a proportional tax: applies the same percentage tax rate to all income levels   a regressive tax: applies a higher tax rate to poorer households   a progressive tax system: taxes higher-income household more heavily (in percentage terms) than lower-income households   Chapter 3

Table 3.1 Distribution of disposable income in Germany in 2014 Group of population Share of aggregate income (%) Lower limit of each group (€) Poorest fifth 7.5 Second fifth 13.5 12,819 Middle fifth 17.6 17,551 Fourth fifth 23.0 22,523 Richest fifth 38.3 29,972 Richest 5 percent 14.7 47,504 Source: Eurostat. Chapter 3

Table 3.2 Distribution of disposable income in Sweden in 2014 Group of population Share of aggregate income (%) Lower limit of each group (Swedish Crown) Lower limit of each group (€) Poorest fifth 8.9 Second fifth 14.8 117,076 18,115 Middle fifth 18.7 151,500 24,232 Fourth fifth 23.2 183,485 29,940 Richest fifth 34.4 225,820 37,817 Richest 5 percent 11.9 319,590 54,316 Source: Eurostat. Chapter 3

Table 3.3 Distribution of Disposable Income in the UK in 2014 Group of population Share of aggregate income (%) Lower limit of each group (British Pounds) Lower limit of each group (€) Poorest fifth 7.8 Second fifth 12.8 8,144 13,088 Middle fifth 17.1 11,448 17,819 Fourth fifth 23.0 15,310 23,835 Richest fifth 39.3 20,802 32,481 Richest 5 percent 15.1 34,730 53,063 Source: Eurostat. Chapter 3

Figure 3.4 Lorenz Curve for German Household Income, 2014 A Lorenz curve is a way of graphically portraying an income distribution. For example, point C indicates that the poorest 60 percent of households received about 39 percent of total household income. If income were perfectly equally distributed, the Lorenz curve would be a straight line from the origin to point E. Chapter 3

Figure 3.5 Lorenz Curves for Disposable Income in Sweden and the UK, 2014 The Lorenz curve for Sweden shows a more equal income distribution than that for the UK, with the curve being closer to the straight line indicating hypothetical perfect equality. Chapter 3

Figure 3.6 The Gini Ratio, A/(A + B) The Gini ratio (or Gini coefficient) sums up the income distribution in a single number: the ratio of the area A to the sum of the areas A and B. If income were perfectly equally distributed, the Gini ratio would be equal to 0. 20 60 40 100 80 Percent of Households Cumulative Percent of Income A B Chapter 3

Figure 3.7 Income shares of the richest 1 percent of households in Britain and Germany 1949–2012 Inequality in most European countries fell after World War II until the late 1970s or early 1980s. From that point on, the share of income going to the richest 1 percent of the population has increased again. Source: Facundo Alvaredo, Anthony B. Atkinson, Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, The World Wealth and Income Database, http://www.wid.world, 15/06/2016. Chapter 3

international trade has been increasing Why has income inequality increased in many European countries over the last four decades? international trade has been increasing new technologies such as computers and biotechnology have become more important real interest rates tended to be much higher from the late 1970s onward than before people today tend to marry partners who have a similar level of education Chapter 3

Why has income inequality increased in many European countries over the last four decades? (cont.) in many European countries, labor market deregulation and reforms to social security systems have changed the relative power of employers and employees in the workplace the compensation given to top executives and board members of large corporations has skyrocketed Chapter 3

Wealth inequality the distribution of wealth (what people own in assets—a “stock”) tends to be much more unequal than the distribution of income (what people receive over a time period—a “flow”) most people own relatively little wealth, relying mainly on labor income or government, nonprofit, or family transfers to support their expenditures negative wealth: value of a person’s debts (such as for a car, house, or credit cards) is greater than the value of her assets Chapter 3

The Three Spheres of Economic Activity

The core sphere core sphere: households, families, and communities that organize resource management, production, distribution, and consumption, usually on a small scale and largely without money when working effectively to support the quality of life, important goods and services are provided to many people e.g. preparing food, raising children, care of the sick and elderly, and leisure time activities Chapter 3

The public-purpose sphere governments and other local, national, and international organizations established for a public purpose beyond individual or family self-interest and not operating with the goal of making a profit two functions: regulation: setting standards or laws to govern behavior direct public provision: the supply of goods or services from government or nonprofit institutions Chapter 3

the profit motive encourages superior efficiency and innovation The business sphere business sphere: firms that produce goods and services for profitable sale business firms are responsive to demands for goods and services as expressed through markets the profit motive encourages superior efficiency and innovation  weakness: business interests may or may not coincide with overall social well-being. Chapter 3

A comparative note: less industrialized economies informal sphere: made up of businesses operating outside government oversight and regulation in less industrialized countries, it may constitute the majority of economic activity informal business activities are often ignored in government-compiled accounts   Chapter 3

Figure 3.8 Social and environmental contexts of economic activity Business Sphere Economic Activity Social Context Physical Context Core Public Purpose Chapter 3

Social and environmental contexts of economic activity businesses (both foreign and domestic), households and communities (the core sphere) and public-purpose institutions (governments and nonprofit organizations) are all involved in productive activities in the economy economies are embedded in a context of larger social institutions and the natural (physical) environment Chapter 3

What to take home the four main economic activities are resource maintenance, production, consumption and distribution inequality in most European countries fell after World War II until the late 1970s or early 1980s. From that point on, inequality has increased again there are competing explanations why income inequality increased in many European countries wealth inequality is higher than income inequality the three spheres of macroeconomic activity are the household sphere, the public-purpose sphere and the business sphere Chapter 3