Private and Public Sectors Households Functional Distribution of Income Personal Distribution of Income

Functional Distribution Wages and salaries: 70% Proprietor’s Income: 5-10 % Combines wage and profit income for self employed Capitalist Income: 20% of Income Corporate profit, rent, interest

Personal distribution of Income Percentage of total income earned by income level. Usually shown as quintiles (20%) groupings. The following chart show the inequality of distribution of income flowing from the unequal distribution of economic abilities and opportunities.

Household as spenders Most household spending is personal consumption. Durable goods spending Non-durable goods spending Services spending Personal Taxes account for some personal spending Saving or (dissaving) accounts for the rest

Business Plant: physical location of production Firm: business org. that owns plant. This is a legal entity Industry: a group of related firms Types of multiplant firms: Horizontally integrated Vertically integrated

Legal Forms of Business Sole Proprietorship Partnerships Corporations Hybrids Each has advantages and disadvantages

Public Sector Provides legal structure Improves allocation of resources by supplying money, product quality, ownership rights, etal Intervention broadens competition and specialization Appropriate intervention is where the MB and MC of govt regulation are equal

Other government roles Maintain competition Redistributes income through transfer payments, modifying prices, taxation Reallocates resources: Spillovers and Externalities Corrects for spillover costs Adjusts for spillover benefits

Other roles continued Provides for quasi-public goods and services Provides for public goods and services Promotes economic stability through changes in taxation and spending (fiscal policy) and/or through the money supply and interest rates (monetary policy)

Govt Finance Govt. Expend. On goods, services, and transfer payments 4 Main areas of expenditures are noted: A. income security B. national defense C. health D. interest on national debt

Taxation Federal: Personal Income Tax (PIT) Marginal and Progressive Corporate Income Tax (CIT) Payroll Taxes (Social Security, Medicare) Excise Taxes

State and Local State revenues are primarily sales and secondly income taxes State spending is greatest on public welfare, education, highways, and health care Local revenues are primarily property taxes and in some cases sales taxes, Local spending is greatest on education and health care.

GDP You must know the definition of GDP You must know the GDP equation You must know what is not included in GDP Remember GDP can be seen as Expenditure or as Income The AP exam will most likely use only the Expenditure approach to GDP

GDP Expenditure Approach C= Personal Consumption Ig= Gross Private Investment in Capital Goods G= Government purchase of Goods and Services Xn= Exports minus Imports GDP= C + Ig + G + Xn

Consumption Includes the purchase of all durable goods, non-durable goods, and services by households or individuals in an economy. Consumption accounts for approximately 70% of total GDP in the United States Underconsumption or lack of spending is considered to be a major factor in creating unemployment (recession) in an economy.

Gross Private Investment INCLUDES: All final purchases of machinery, equipment, and tools by business All construction including residential homes Changes in business inventory* Gross Private Investment minus depreciation (consumption of fixed capital) equals Net Private Investment. If depreciation or CFC exceeds Ig then the economies’ productive capacity declines. If CFC is less than Ig the economies’ productive capacity increases. *If output exceeds current sales inventory builds. If sales outpace output inventory will be a negative portion of Ig.

Government Expenditures This should be read as GOVERNMENT PURCHASES of GOODS and SERVICES. This (G) includes all levels of government in the US. Federal, state, and local Includes all direct purchases particularly labor Excludes transfer payments (social security, unemployment, welfare, food stamps, VA payments etc,) because these payments do NOT reflect current output (production)* *However, these payments usually end up in C

Net Exports All spending on goods made in the US MUST be included in GDP regardless of where they are purchased. Also many goods purchased in the US are NOT produced here and should not be included in US GDP. Therefore, we must include in GDP those things made here that are sold abroad and exclude those things purchased here that are produced abroad. The economic names for these are EXPORTS-THOSE THINGS MADE HERE SOLD ABROAD IMPORTS-THOSE THINGS SOLD HERE MADE ABROAD ERGO: Exports (X) – Imports (I) = Xn

Nominal Vs. Real All GDP must be adjusted for inflation or deflation. In order to do this one must apply a GDP deflator. In this class the normal deflator will be the Consumer Price Index.

Nominal vs. Real To deflate or inflate GDP a base year must be chosen. The price index for that year is always equal to 1.00 x 100 or 100. From the base year one can then determine the true value of GDP for any given year by dividing the price index for that year into the nominal GDP monetary figure

THE Consumer Price Index The index is a market basket of all goods and services purchased by a normal urban household. These prices are checked periodically and the basket itself is changed as times change The GDP price index (which is normally not used in beginning classes) is more formal and is adjusted yearly to account for change in the composition of output.

INSTABILITIES Capitalism is an inherently unstable economic systems because it is based on the decisions of individuals who have the freedom to change what they do when they want. This introduces instabilities into the system. The TWO main types of instability in capitalism are UNEMPLOYMENT and INFLATION

Growth and the Business Cycle Economic growth can be defined two ways: as an increase in real GDP over time, or and increase in real GDP per capita. The second is the one usually used as it is more sensitive to living standards than the first. Growth is important because it lessens the burden of scarcity Using the RULE of 70 one can determine the amount of time it would take real GDP or real GDP per capita to double. Main sources of growth are increases in resources and increases in the productive use of resources. About 2/3 of US growth comes from increases in productivity.

Some Caveats to Growth as an Indicator Does not measure improvements in quality Does not measure increased or decrease leisure time Does not take into account environmental effects or allocative needs of the population

The Business Cycle The economy experiences a cyclical movement over time. This is the BUSINESS CYCLE It is divided into 4 phases which are: PEAK RECESSION TROUGH RECOVERY

BUSINESS CYCLES AND CAUSATION Major innovation may trigger new investment and/or consumption spending Lack of innovation may do the opposite Change in productivity either positively or negatively may help to incur a cycle Levels of aggregate spending (AD) particularly in the volatile investment (Ig) may also be causative.