The Evolving U.S. Economy in Perspective Chapter 3

Laugher Curve Frank: According to this economist, Ernie, it’s all very simple. In an endogenous business cycle where variable-span diffusion indices are neither rising nor falling and the capital-to-output ratio is low, then the interplay of liquidity preferences and reserve ratios escalates and interest rates rise, causing the yield ratio to drop on common stocks.

Laugher Curve Ernie: I get it! In other words, when the economy goes higgledy-piggledy, the Dow goes blooey!

The U.S. Economy in Historical Perspective The U.S. economy is a market economy. A market economy is an economic system based on private property and the market.

The U.S. Economy in Historical Perspective A market economy gives private property rights to individuals, and relies on market forces to coordinate economic activity. Private property rights – the control a private individual or firm has over an asset or a right.

How Markets Work Markets work through a system of rewards and payments. Individuals are free to whatever they want as long as it’s legal.

How Markets Work Fluctuations in prices play a central role in coordinating individuals’ wants in a market economy. If there is not enough of something, its price goes up. If there is too much, price goes down.

What’s Good About the Market? Most economists believe the market is a good way to coordinate individuals' activities.

What’s Good About the Market? The primary debate among economists is about how markets should be structured. Whether markets should be modified and adjusted by government regulation.

Capitalism and Socialism Socialism – an economic system based on individuals’ good will toward others, not on their own self-interest. In principle, society decides what, how, and for whom to produce.

Capitalism and Socialism Capitalism – an economic system based upon the market. The ownership of the means of production resides with a small group of individuals called capitalists.

Socialism in Theory Socialism – an economic system that tries to organize society in the same way as families are organized. Everyone contributes what they can and get what they need.

Socialism in Practice Socialism in practice is often called Soviet-style socialism. Soviet-style socialist economies used administrative control or central planning to solve the coordination problems: what, how, and for whom.

Socialism in Practice By the 1960s, Western Europe had major welfare support systems and governments very much involved in their market economies.

Socialism in Practice Since the 1990s, people have talked little about differences in economic systems. Instead, they have talked about differences in institutions.

Socialism in Practice Even countries that call themselves socialist are hardly differentiable from market economies.

Evolving Economic Systems Economic systems and the institutions that make them up are constantly evolving.

Evolving Economic Systems Feudalism dominated the Western world from about the 8th to the 15th century. Feudalism is an economic system in which traditions rule.

Evolving Economic Systems Feudalism gave way to mercantilism. Mercantilism is an economic system in which government determines the what, how, and for whom decisions by doling out the rights to undertake certain economic activities.

Evolving Economic Systems Mercantilism gave way to the Industrial Revolution. Industrial revolution – a time when technology and machines rapidly modernized industrial production and mass-produced goods replaced handmade goods.

Evolving Economic Systems Capitalism evolved from the Industrial Revolution.

The U.S. Economy The U.S. economy is divided into three groups: business, households, and government.

The U.S. Economy Households supply factors of production to business and are paid by business for doing so. This takes place in the factor market.

The U.S. Economy Business produces goods and services and sells them to households and government. This takes place in the goods market.

The U.S. Economy Exports and imports provide an international connection.

The U.S. Economy Government: Buys goods and services from business and buys labor services from households. Provides services to both business and households.

The U.S. Economy Government: Gives some of its tax revenues directly back to individuals (income redistribution). Oversees the interaction of business and households in the goods and factor markets.

The U.S. Economy

Business Business is the name given to private producing units in our society. Businesses decide what to produce, how much to produce, and for whom to produce it.

What Do U.S. Firms Produce? As the U.S. economy has evolved, the relative importance of services has increased.

Consumer Sovereignty and Business Businesses produce what they believe will sell. Consumer sovereignty means that consumers’ wishes rule what is produced by businesses.

Consumer Sovereignty and Business Before deciding to start a business, the key question is: “Can I make a profit?” Profit is what’s left over from total revenues after all the appropriate costs have been subtracted.

Consumer Sovereignty and Business By channeling the desire to make a profit for the general good of society, the U.S. economic system allows the invisible hand to work.

Forms of Business There are three major types of businesses: Sole Proprietorship – businesses that have only one owner. Partnership – businesses with two or more owners.

Forms of Business There are three major types of businesses: Corporation – Businesses that are treated as a person and are legally owned by their stockholders who are not liable for the actions of the corporate "person."

Forms of Business A corporation issues stock and provides its owners with limited liability. Stock – certificates of ownership in a company. Limited liability – the stockholder’s liability is limited to the amount that stockholder has invested in the company.

Forms of Business By Numbers By Receipts Sole proprietorships (72%) Corporations (86%) Corporations (20%) Partnerships (9%) Partnerships (8%) Sole proprietorships (5%)

Sole Proprietorship Advantages: Disadvantages: Minimum bureaucratic hassle. Direct control by owner. Disadvantages: Limited ability to get funds. Unlimited personal liability.

Partnership Advantages: Disadvantages: Ability to share work and risks. Relatively easy to form. Disadvantages: Unlimited personal liability (even for partner's blunder). Limited ability to get funds.

Corporation Advantages: No personal liability. Increasing ability to get funds. Ability to shed personal income and gain added expenses.

Corporation Disadvantages: Legal hassle to organize. Possible double taxation of income. Monitoring problems.

Finance and Business By selling stocks and bonds, corporations can finance expansions and new investments. Accounting statements are an important tool investors use to decide where to invest.

E-Commerce and the Digital Economy E-commerce refers to buying and selling over the internet. It brings people together at a low cost in a virtual marketplace where geographical location doesn’t matter. It adds competition, increases information, and reduces the importance of geography.

Households Households – groups of individuals living together and making joint decisions. In the economy, households vote with their dollars.

The Power of Households Consumer sovereignty reigns, but it works indirectly by influencing business. Households are often not active producers of output but merely passive recipients of income.

Households as Suppliers of Labor The largest source of household income is wages and salaries. Households supply the labor with which businesses produce and government governs.

Households as Suppliers of Labor Many of the fastest growing jobs are in service industries. Many of the fastest declining jobs are in manufacturing and agriculture.

Government Government plays two general roles in the economy: A referee – sets the rules that determine relations between businesses and households. An actor – collects money in taxes and spends that money on its own projects, such as defense and education.

Government as an Actor All levels of government consume about 20 percent of the nation’s total output and employ about 21 million persons.

Government as an Actor State and local government employ 18 million workers and spend over $1 trillion per year. Tax revenues are spent on administration, education, and roads.

Government as an Actor Income taxes make up 50 percent of the federal government’s revenue. The two largest categories of spending are income security and defense.

Income of State and Local Government Intergovernmental (22%) Property tax (20%) Other (20%) Individual and corporate income tax (20%) Sales or gross receipts (20%)

Expenditures of State and Local Government Central government administration (10%) Transportation (7%) Other (21%) Civilian safety (14%) Health and Hospitals (21%) Public welfare (9%) Education (37%)

Income of the Federal Government Social security taxes and contributions (20%) Individual income taxes (20%) Excise taxes and other (20%) Corporate income taxes (20%)

Expenditures of the Federal Government Health and education (26%) Interest (13%) Other (11%) National defense (18%) Income security (33%)

Government as a Referee Government sets the rules of interaction between households and business. It acts as a referee, changing the rules when it sees fit. It decides whether the invisible hand will be allowed to operate freely.

The U.S. Economy and Globalization It is impossible to talk about U.S. economic institutions without considering how those institutions integrate with the world economy.

Global Corporations Global corporations – corporations with substantial operations on both the production and sales sides in more than one country.

Global Corporations Global corporations create jobs, bring new ideas and new technologies to a country, and provide competition for domestic companies.

Global Corporations There is no global government to regulate or control global corporations. They can shift operations to another country they don’t like the policies of the host country.

Global Markets The World Trade Organization (WTO) is committed to getting nations to agree not to impost new tariffs or other trade restrictions except under certain limited conditions.

Global Markets The global economy gives firms a lot more places to search for business. The internet reduces the cost of that search significantly. Globalization increases the number of potential competitors for business

Global Markets Globalization increases competition by allowing greater specialization and division of labor. This leads to increased growth and better living standards for everyone.

Surviving in a Global Economy Companies operating in the global economy must continually look for way to improve efficiency and lower cost.

Surviving in a Global Economy Globalization lets companies take advantage of cost differentials across countries. Specialization and division of labor helps hold down prices and wages firms pay for the factors of production.

Does Globalization Eliminate Jobs? Global trade increases total production. Globalization eliminates some jobs, but it also creates jobs.

Dealing with Globalization Governments have developed a variety of international institutions to promote negotiations and coordinate economic relations.

Dealing with Globalization International organizations that encourage international cooperation include: The United Nations (UN) – has no ability to tax and no ability to independently impose its will on its members

Dealing with Globalization International organizations that encourage international cooperation include: The World Bank – a multinational, international financial institution that works with developing countries to secure low-interest loans.

Dealing with Globalization International organizations that encourage international cooperation include: The International Monetary Fund (IMF) – a multinational, international financial institution concerned primarily with monetary issues.

Dealing with Globalization There are also informal organizations: Group of Five – Japan, Germany, Britain, France, and the U.S. –meets to promote negotiations and coordinate economic relations among nations. Group of Seven – includes the Group of Five plus Canada and Italy – does much the same work as the Group of Five

The Evolving U.S. Economy in Perspective End of Chapter 3