The U. S. Economy: Private and Public Sectors Chapter 4

US Economy Economists divide the economy into three groups: households businesses government

Households

Households Households are: One or more people living together in a housing unit, supplying the economy with labor and purchasing products There are about 114 million households

Several different ways to measure and compare household incomes

Households The Functional Distribution of Income is; - How the nation’s earned income is distributed between the different functions (categories) of wages, profits, rents and interest.

Households The Personal Distribution of Income is; - How the nation’s earned income is distributed between different households.

Households Households on average: Pay 13% of their income in personal taxes Save 1% of their income Spend 86% of their income

Households Households save: For security – to have income in retirement, in case of emergencies, to pay for college For speculation – to have more money in the future

Households Household income, savings and consumption are directly related: The higher the income, the more people spend The higher the income, the more people save

Businesses

Businesses Businesses are: An organization, usually in existence to produce a profit for owners, which combines labor, capital and other resources to produce products.

Businesses Plant Firm Industry A physical establishment A business organization that owns and operates plants Industry A group of firms that produce the same or similar products

Businesses: Types of Ownership Sole proprietorship A single owner Partnership Two or more owners Corporation A legal entity that can perform the functions of any business entity. Owned by stockholders

Businesses: Advantages of Corporations Limited liability for stockholders They don’t risk anything except the value of their stocks Ability to raise funds Large companies find it easier to raise money Political and economic power Large corporations can alter the marketplace, or influence government, to meet their desires

The Role of the Government

Government Notice that the emphasis is on the minimal role government plays. For some people even this little is too much. For others, the government can and should do more.

Government Functions Provide the legal structure Maintain competition Redistribute income Correct market failures Promote stability

Government: Legal Structure The government should provide the legal structure for the effective functioning of the capitalist (market) system. This includes courts and police to fight crime and enforce contracts.

Government: Legal Structure The legal structure also includes a state strong enough to pass laws and enforce contracts. Russia is the example of a state that is too weak: the mafia took over the country.

Government: Maintain Competition The most efficient economic system is competition. But there appears to be a natural tendency for competition to end and monopolies to emerge. Government should provide the legal structure to fight monopolies.

Government: Redistribute Income All democratic governments redistribute income, as a result of popular beliefs about fairness, justice, and lobbying for special groups.

Government: Correcting Market Failures Market failures take place when firms produce the wrong amount of certain products Or when markets fail to allocate resources to produce necessary products.

Government: Correcting Market Failures The first leads to spillovers The second involves public goods

Spillovers

Correcting Market Failures: Spillovers Spillovers take place when costs or benefits of an economic activity are passed on to parties who are neither buyers nor sellers in that activity.

Correcting Market Failures: Negative Spillovers A negative spillover occurs when economic activities inflict costs on third parties. Examples of negative spillovers include all types of pollution.

Correcting Market Failures: Negative Spillovers In the case of spillovers, the government needs to find some mechanism to either pass the costs onto offending firms, or get them to change their behavior.

Correcting Market Failures: Negative Spillovers Governments can raise taxes on the polluting firms. Or it can pass laws to force the companies to change their behavior

Correcting Market Failures: Positive Spillovers A positive spillover occurs when economic activities benefit someone in addition to the buyer and seller of a product. Examples of positive spillovers include all types of education, libraries, immunization shots.

Correcting Market Failures: Positive Spillovers In the case of positive spillover, the market system doesn’t produce enough of the product.

Correcting Market Failures: Positive Spillovers In the case of positive spillovers, the government needs to increase demand, or increase supply, or produce the product itself.

Correcting Market Failures: Negative Spillovers Governments can raise taxes on the polluting firms. Or it can pass laws to force the companies to change their behavior

Public Goods

Correcting Market Failures: Public Goods Public goods are products that are economically and socially justifiable, but which no private firm will produce.

Correcting Market Failures: Private Goods Are produced by firms and have two characteristics Private goods have excludability and rivalry

Correcting Market Failures: Private Goods Excludability Buyers who are willing and able to pay the market price enjoy the benefits of buying the product. People who can’t afford the good, don’t enjoy the benefits

Correcting Market Failures: Private Goods Rivalry Means when one person buys the good, no one else can buy or use them. If I buy a pair of jeans, no one else can buy or use them.

Correcting Market Failures: Public Goods Are usually produced by governments and have two characteristics Public goods have non-excludability and non-rivalry

Correcting Market Failures: Public Goods Nonexcludability People who buy the good or service benefit, but so do people who don’t buy the product. Street lighting, flu shots

Correcting Market Failures: Public Goods Nonrivalry If I buy the product, other people can still use it. If I “buy” a national defense, everyone else can enjoy the benefits as well.

Correcting Market Failures: Public vs. Private Goods The line between public and private goods is not sharp. It varies from one society to another, and from one time period to another.

Government: Promoting Stability Governments should also control inflation and reduce unemployment. Too much of either is bad for the economy, and ultimately, businesses.

Federal Finance

Government: Federal Budget Notice the charts on page 85. Notice how much goes to defense. Notice how the tax structure lightly taxes corporations and the wealthy, compared to other countries.

Government: State Budgets The primary tax revenue for states is sales and excise taxes.