Economic Decision Makers Chapter 3 Economic Decision Makers © 2009 South-Western/Cengage Learning

The Household Demand goods and services Supply resources Choices What gets produced Supply resources Produce output Choices

The Household Utility: Maximize utility Supply resources Satisfaction gained from the consumption of a good or service Maximize utility Supply resources Demand goods and services

Exhibit 1 Where U.S. personal income comes from and where it goes Over two-thirds of personal income in 2006 was from wages, salaries, and proprietors income (b) Half of U.S. personal income in 2006 was spent on services

Transfer Payment payment to an individual in exchange for no work

The Evolution of the Firm Specialization Comparative advantage Transaction costs Entrepreneur Cottage industry system Technological developments

The Evolution of Firm Factories Industrial Revolution Efficient division of labor Direct supervision of production Reduce transportation costs Bigger machines Industrial Revolution

Coordination of tasks Market coordination Managerial coordination uses price as signals and incentives Managerial coordination uses management within firm Transactions costs costs other than production costs of carrying out a transaction

The Firm Firms Economic units Entrepreneurs Combine resources Produce goods and services Maximize profit

Types of Firms Sole proprietorship Partnership owned and operated by one person who receives all profit and bears all liability Partnership association of 2 or more people who operate a business as co-owners by voluntary legal agreement

Types of Firms Corporation independent legal entity with ownership divided into equal shares and each owner’s liability limited to his/her investment in the company

Exhibit 2 Number and sales of each type of firm Most firms are sole proprietorships (b) Corporations account for most sales

Types of Firms Not-for-profit organizations Charitable Educational Humanitarian Cultural Professional

Household Production Opportunity cost Below market price No skills or special resources are required Avoid taxes Reduce transaction costs Technological advance

The Government Establish & enforce rules of the game Promote competition Regulate natural monopolies Provide public goods Deal with externalities More equal distribution of income Full employment Price stability Economic growth

The Government Market Failure market fails to efficiently or equitably allocate scarce resources.

Sources of Market Failure Externalities costs or benefits associated with a transaction not borne by the decision makers Public goods nonrival in consumption nonexclusion Imperfect Competition Income Distribution

Government’s Structure, Objectives National/federal government National security, economic stability, market competition State government Public higher education, prisons, highways, welfare Local government Primary and secondary education, police, fire protection

Government’s Structure, Objectives Difficulty 87,600 jurisdictions 1 nation 50 states 3,034 counties 35,933 cities and towns 13,506 school districts 35,052 special districts Not a single decision maker ‘Vote maximization’

Government’s Structure, Objectives Voluntary exchange vs. coercion Some government coercion Enforced by the police No market prices Public output Zero price Below the production cost

The Size and Growth of Government Government outlays relative to GDP 1929: 10% of GDP Mostly state and local 2007: 37% of GDP Mostly federal Defense Decreased Redistribution Increased

Exhibit 3 Redistribution has grown and defense has declined as share of federal outlays since 1960

Sources of Government Revenue Taxes Individual income tax (federal) Income tax; sales tax (state) Property tax (local) User charges Borrowing Monopolize certain markets

Tax Principles Ability-to-pay tax principle Benefits-received tax principle

Tax Incidence Proportional tax tax rate is same for all Progressive tax tax rate increases as income increases Top 1% of tax filers – paid 36.9% of taxes Top 10% of tax filers – paid 68.2% of taxes Bottom 50% of tax filers – paid 3% of taxes Regressive tax tax rate decreases as income increases

Income Tax rate Tax paid $10,000 50,000 100,000 20 $2,000 10,000 20,000 25 30 12,500 30,000 15 10 7,500

Exhibit 4 Payroll taxes have grown as a share of federal revenue since 1960

Exhibit 5 Top marginal rate on federal personal income tax since 1913

The Rest of the World Foreign households, firms, governments International trade - different opportunity costs Merchandise trade balance Value of a country’s exports minus the value of its imports Balance of payments

Rest of the World Exchange rate Trade restrictions Shows the price, in terms of one nation’s currency, at which another nation’s currency can be purchased Trade restrictions Tariff tax on imports Quota legal limit on imports