1. The U.S. Economy: Private and Public Sectors Chapter 4 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives U.S. household and business facts The corporate form of business organization Principle agent problem The economic role of government Government spending and sources of revenue 4-2

3. Household Income Functional distribution of income –Types of income –Wage, rent, interest, profit Personal distribution of income –Division among households by quintile 4-3

4. Functional Distribution of Income 2007 Wages & Salaries Rents Interest Proprietor’s Income Corporate Profits Income By Function Performed National Income Received (Percent) 0 10 20 30 40 50 60 70 71% 1% 5% 9% 14% Source: Bureau of Economic Analysis 4-4

5. Personal Distribution of Income 2006 Lowest 20% Second 20% Middle 20% Fourth 20% Highest 20% Income Group (Households) Personal Income Received (Percent) 0 10 20 30 40 50 60 3.4% 8.6% 14.5% 22.9% 50.5% Source: Bureau of the Census 4-5

6. Households as Spenders Uses of household income? Personal taxes (13%) Personal saving (1%) Personal consumption (86%) –Durables (11%) –Nondurables (29%) –Services (60%) 4-6

7. The Business Population Plant Firm Industry Multiplant firms Vertically integrated Conglomerates 4-7

8. Domestic Output Percentage of FirmsPercentage of Sales Sole Proprietorships Partnerships Corporations Sole Proprietorships Partnerships Corporations 72% 8% 20% 5% 11% 84% Source: U. S. Census Bureau Sole proprietorship Partnership Corporation 4-8

9. Advantages of Corporations Methods of finance –Stocks –Bonds Limited liability Hiring of specialists Unlimited lifetime 4-9

10. Principal-Agent Problem Potential disadvantage of corporations Stockholders are principals Executives are agents Conflict of interest? 4-10

11. The Public Sector Federal, state, and local government Role of the government in the economy? 4-11

12. Government’s Role Provide the legal structure –Set the laws we live by Maintain competition –Monopoly and antitrust laws Redistribute income –Transfer payments –Market intervention –Taxation 4-12

13. Government’s Role Reallocating resources –Market failure –Negative externality –Positive externality –Public goods 4-13

14. Correcting for Externalities Negative externalities –Legislation –Specific taxes Positive externalities –Subsidies –Government provision of goods 4-14

15. Types of Goods Private goods –Rival and excludable Public goods –Nonrival –Nonexcludable –Free-rider problem Quasi-public goods The reallocation process 4-15

16. Government’s Role Promoting stability –Unemployment –Inflation A qualification –Politics –Too much or too little regulation –Inefficiency 4-16

17. The Circular Flow Revisited Resource Market Product Market BusinessesHouseholdsGovernment Goods & Services Goods & Services Net Taxes Expenditures Goods & Services Resources 4-17

18. Government Finance Government purchases Government transfers 35 30 25 20 15 10 5 0 Percentage of U.S. Output 19602007 Government Purchases Government Transfer Payments 22% 5% 19% 13% 27% 32% 4-18

19. Government Revenue Sweden Denmark Finland France Italy Germany United Kingdom Canada Australia United States Japan South Korea 1020304050 Source: Organization for Economic Cooperation and Development 58 55 51 46 43 42 40 35 34 33 32 Total Tax Revenue, Approximate Percentage of GDP, 2007 4-19

20. Federal Expenditures 01020304050 Pensions & Income Security National Defense Health Interest on the Public Debt Source: U. S. Office of Management and Budget 34% 21% 24% 9% Percentage of total expenditure ($2,731 billion), 2007 4-20

21. Federal Tax Revenues 01020304050 Personal Income Tax Payroll Taxes Corporate Income Taxes Excise Taxes Source: U. S. Office of Management and Budget 45% 34% 3% 4% All Other 14% Sources of total tax revenue ($2,568 billion), 2007 4-21

22. Personal Income Tax Progressive tax rates –Brackets of income Marginal tax rate Average tax rate 4-22

23. State Finances Primary Revenues Sales & Excise Taxes (47%) Personal Income Taxes (35%) Corporate Income Taxes & License Fees (18%) 4-23

24. State Finances Primary Expenditures Education (36%) Public Welfare (28%) Health & Hospitals (7%) Highways (7%) Public Safety (4%) Other (18%) 4-24

25. Local Finances Primary Revenues Property Taxes 73% Sales & Excise Taxes 17% Primary Expenditures Education 44% Welfare, Health & Hospitals 12% Public Safety 11% Housing, Parks, & Sewers 8% Streets & Highways 5% 4-25

26. Financing Social Security Demographic changes Long-run shortfall in funding Pay-as-you-go plan Trust fund withdrawals Trust fund exhausted in 2041 Benefit reductions? Tax revenue increases? 4-26

27. Financing Social Security Possible solutions –Stock & bond investments –Payroll tax increases –Individually directed accounts –Privately owned and managed accounts Consensus difficult 4-27

28. Key Terms functional distribution of income personal distribution of income durable goods nondurable goods services plant firm industry sole proprietorship partnership corporation stock bond limited liability principal-agent problem monopoly externality negative externalities positive externalities public goods free-rider problem quasi-public goods government purchases transfer payments personal income tax marginal tax rate average tax rate payroll taxes corporate income tax sales and excise taxes property taxes 4-28

29. Next Chapter Preview… The United States in the Global Economy 4-29