Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The U.S. Economy in a Global Setting Chapter 3

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 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.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Laugher Curve Ernie:I get it! In other words, when the economy goes higgledy-piggledy, the Dow goes blooey!

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The U.S. Economy u Ultimately the U.S. economy’s strength is its people and its other resources. u The U.S. economy is far from perfect.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Diagram of the U.S. Economy u The U.S. economy is divided into three groups: business, households, and government.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Diagram of the U.S. Economy u Households supply factors of production to business and are paid by business for doing so. The place where this takes place is called the factor market.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Diagram of the U.S. Economy u Business produces goods and services and sells them to households and government. The place where this takes place is called the goods market.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Diagram of the U.S. Economy u Government engages in the following activities: It buys goods and services from business and buys labor services from households. It provides services to both business and households.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Diagram of the U.S. Economy u Government engages in the following activities: It gives some of its tax revenues directly back to individuals (income redistribution). It oversees the interaction of business and households in the goods and factor markets.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Diagram of the U.S. Economy

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Business u Business is the name given to private producing units in our society. l Businesses decide what to produce, how much to produce, and for whom to produce it. l Business is responsible for over 80 percent of U.S. production.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Entrepreneurship and Business u Entrepreneurship is the ability to organize and get something done. u It is an important part of business, and an important ingredient in the economy.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Consumer Sovereignty and Business u Although businesses decide what to produce, they are guided by consumer sovereignty. u Consumer sovereignty means that consumers’ wishes rule what is produced by businesses.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Consumer Sovereignty and Business u 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.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Consumer Sovereignty and Business u 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.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Forms of Business u There are three major types of businesses: sole proprietorships, partnerships, and corporations.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Forms of Business Sole proprietorships (73%) Corporations (89%) Corporations (20%) Partnerships (7%) Partnerships (6%) Sole proprietorships (5%) By Numbers By Receipts

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Sole Proprietorship u Businesses that have only one owner. u Advantages: l Minimum bureaucratic hassle. l Direct control by owner. u Disadvantages: l Limited ability to get funds. l Unlimited personal liability.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Partnership u Businesses with two or more owners. u Advantages: l Ability to share work and risks. l Relatively easy to form. u Disadvantages: l Unlimited personal liability (even for partner's blunder). l Limited ability to get funds.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Corporation u 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."

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Corporation u Advantages: No personal liability. Increasing ability to get funds. Ability to shed personal income and gain added expenses.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Corporation u Disadvantages: Legal hassle to organize. Possible double taxation of income. Monitoring problems.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Finance and Business u The dynamic stock market allows initial public offerings (IPOs) to quickly amass capital and to make their owners rich. u It is difficult to over emphasize the importance of e-commerce and the digital economy.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Households u Households are a single person or groups of related or unrelated persons living together and making decisions. u In the economy, households vote with their dollars.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The Power of Households u Households ultimately control the other two economic institutions – government and business.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The Power of Households u In many spheres of the economy households are not active producers of output but merely passive recipients of income.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Households as Suppliers of Labor u The largest source of household income is wages and salaries. u Households supply the labor with which businesses produce and government governs.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Households as Suppliers of Labor u The jobs trend toward more service- related jobs away from manufacturing is continuing. The fastest gains are in services while the fastest declining are in manufacturing and agriculture.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Government u Two general roles of government are: l An actor – collects money in taxes and spends that money on its own projects, such as defense and education. l A referee – sets the rules that determine relations between businesses and households.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Government as an Actor u All levels of government consume about 20 percent of the nation’s total output and employ about 21 million persons.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin State and Local Government u State and local government employ 18 million workers and spend about $1 trillion per year. u They spend their tax revenues on administration, education, and roads.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Income of State and Local Government 14% 21% 15% 14% 18% Insurance trust revenue Sales or gross receipts Individual and corporation income tax Property tax Intergovernmental Other

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Expenditures of State and Local Government 6% 12% 10% 36% 23% 2% 11% Central government administration Transportation Civilian safety Education Public welfare Health and hospitals Other

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Federal Government u Income taxes make up 53 percent of the federal government’s revenue, while payroll taxes make up about 40 percent. u The two largest categories of spending are income maintenance and defense.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Income of the Federal Government 48% 33% 11% 8% Individual income taxes Social insurance taxes and contributions Corporate income taxes Excise taxes and other

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Expenditures of the Federal Government 13% 4% 50% 19% 14% Interest Health and education Income security National defense Other

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Government as a Referee u Government controls the interaction of households and business u It sets the rules of interaction and acts as a referee, changing the rules when it sees fit. u It decides whether the invisible hand will be allowed to operate freely.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The Global Setting u International issues must now be taken into account in just about any economic decision a country or a firm faces.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Global Corporations u Those with substantial operations on both the production and sales sides in more than one country are becoming increasingly important.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Global Corporations u Global corporations offer great benefits for nations. Global corporations create jobs, bring new ideas and new technologies to a country, and provide competition for domestic companies, keeping them on their toes.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Global Corporations u Global corporations pose a number of problems for governments. Because a global corporation exists in a number of nations, no single government regulates or controls it. If they don’t like the policies of the host nation, they can simply leave taking their jobs with them.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Global Corporations u Global corporations sometimes act as governments unto themselves – they can dominate the economy of a small nation.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin International Trade u Sometimes international trade has grown rapidly u Other times it has grown slowly.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin International Trade u Fluctuations in world trade result in part from fluctuations in world output. Fluctuations are also explained in part by trade restrictions that nations have imposed from time to time.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Differences in the Importance of Trade u The importance of international trade to countries’ economies differs widely. u For most nations, imports and exports roughly correspond.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin What and With Whom the U.S. Trades u The primary trading partners of the U.S. are Canada, Mexico, the European Union, and Pacific Rim countries. u The majority of U.S. exports and imports involve manufactured goods.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin What and With Whom the U.S. Trades u U.S. imports have exceeded exports in recent years leading the balance of trade to show a trade deficit rather than a trade surplus.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin What and With Whom the U.S. Trades u Balance of trade – the difference between the value of exports and the value of imports

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin What and With Whom the U.S. Trades u Trade deficit – an excess of imports over exports. Trade surplus – an excess of exports over imports.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin U.S. Exports by Region, % 23% 3%8% 27% 6% 21% Mexico Canada OPEC Central and South America Pacific Rim Other Europe European Union

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin U.S. Imports by Region, % 19% 4% 6% 35% 6% 19% Mexico Canada OPEC Central and South America Pacific Rim Other Europe European Union

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Debtor and Creditor Nations u Following World War II, the U.S. ran trade surpluses. u In recent years, the U.S. has run a significant trade deficit.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin How International Trade Differs From Domestic Trade u International trade involves potential barriers to trade. l Quotas are limitations on how much of a good can be shipped into a country. l Tariffs are taxes on imports. l Nontariff barriers are indirect regulatory restrictions on imports and exports.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin How International Trade Differs From Domestic Trade u International trade involves multiple currencies that are bought and sold in foreign exchange markets.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin How International Trade Differs From Domestic Trade u The exchange rate determines how much various goods will likely cost in different countries. The exchange rate is the rate at which one currency is traded for another.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Institutions Supporting Free Trade u Most economists, liberal and conservative alike, generally oppose trade restrictions.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Free Trade Organizations

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Free Trade Organizations u Despite political pressures to restrict trade, nations have entered into a variety of international agreements and organizations.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Free Trade Organizations u 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.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Free Trade Organizations u The WTO is the successor to the General Agreement on Tariffs and Trade (GATT) – an agreement among many subscribing nations on certain conditions of international trade.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Free Trade Organizations u The push for free trade has a geographic dimension. Groups of nations have formed free trade associations – groups of nations that have reduced or eliminated trade barriers among themselves.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin NAFTA – U.S.-Canada-Mexico free trade zone that is phasing in reductions in tariffs. Free Trade Organizations u The leading example of this are the European Union (EU) and the North American Free Trade Agreement (NAFTA).

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin International Economic Policy Organizations u There is no international counterpart to the U.S. federal government. u Any meeting of a group of nations to discuss trade policy is voluntary. u There is no international body that has powers of compulsion.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin International Economic Policy Organizations u Governmental international organizations that encourage international cooperation include: The United Nations (UN) The World Bank – a multinational, international financial institution that works with developing countries to secure low-interest loans.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin International Economic Policy Organizations u Governmental international organizations that encourage international cooperation include: The International Monetary Fund (IMF) – a multinational, international financial institution concerned primarily with monetary issues.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin International Economic Policy Organizations u There are also informal organizations such as: The Group of Five (Japan, Germany, Britain, France, and the U.S.) which meets to promote negotiations and coordinate economic relations among nations.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin International Economic Policy Organizations u There are also informal organizations such as: The Group of Seven, which includes the Group of Five plus Canada and Italy, and does much the same work as the Group of Five

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The U.S. Economy in a Global Setting End of Chapter 3