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

2. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 2 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.

3. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 3 Laugher Curve Ernie:I get it! In other words, when the economy goes higgledy-piggledy, the Dow goes blooey!

4. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 4 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.

5. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 5 Diagram of the U.S. Economy u The U.S. economy is divided into three groups: business, households, and government.

6. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 6 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.

7. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 7 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.

8. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 8 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.

9. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 9 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.

10. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 10 Diagram of the U.S. Economy

11. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 11 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.

12. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 12 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.

13. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 13 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.

14. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 14 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.

15. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 15 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.

16. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 16 Forms of Business u There are three major types of businesses: sole proprietorships, partnerships, and corporations.

17. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 17 Forms of Business Sole proprietorships (73%) Corporations (89%) Corporations (20%) Partnerships (7%) Partnerships (6%) Sole proprietorships (5%) By Numbers By Receipts

18. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 18 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.

19. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 19 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.

20. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 20 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."

21. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 21 Corporation u Advantages: No personal liability. Increasing ability to get funds. Ability to shed personal income and gain added expenses.

22. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 22 Corporation u Disadvantages: Legal hassle to organize. Possible double taxation of income. Monitoring problems.

23. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 23 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.

24. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 24 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.

25. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 25 The Power of Households u Households ultimately control the other two economic institutions – government and business.

26. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 26 The Power of Households u In many spheres of the economy households are not active producers of output but merely passive recipients of income.

27. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 27 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.

28. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 28 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.

29. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 29 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.

30. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 30 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.

31. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 31 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.

32. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 32 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

33. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 33 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

34. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 34 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.

35. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 35 Income of the Federal Government 48% 33% 11% 8% Individual income taxes Social insurance taxes and contributions Corporate income taxes Excise taxes and other

36. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 36 Expenditures of the Federal Government 13% 4% 50% 19% 14% Interest Health and education Income security National defense Other

37. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 37 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.

38. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 38 The Global Setting u International issues must now be taken into account in just about any economic decision a country or a firm faces.

39. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 39 Global Corporations u Those with substantial operations on both the production and sales sides in more than one country are becoming increasingly important.

40. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 40 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.

41. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 41 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.

42. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 42 Global Corporations u Global corporations sometimes act as governments unto themselves – they can dominate the economy of a small nation.

43. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 43 International Trade u Sometimes international trade has grown rapidly u Other times it has grown slowly.

44. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 44 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.

45. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 45 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.

46. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 46 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.

47. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 47 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.

48. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 48 What and With Whom the U.S. Trades u Balance of trade – the difference between the value of exports and the value of imports

49. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 49 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.

50. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 50 U.S. Exports by Region, 1999 12% 23% 3%8% 27% 6% 21% Mexico Canada OPEC Central and South America Pacific Rim Other Europe European Union

51. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 51 U.S. Imports by Region, 1999 11% 19% 4% 6% 35% 6% 19% Mexico Canada OPEC Central and South America Pacific Rim Other Europe European Union

52. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 52 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.

53. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 53 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.

54. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 54 How International Trade Differs From Domestic Trade u International trade involves multiple currencies that are bought and sold in foreign exchange markets.

55. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 55 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.

56. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 56 Institutions Supporting Free Trade u Most economists, liberal and conservative alike, generally oppose trade restrictions.

57. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 57 Free Trade Organizations

58. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 58 Free Trade Organizations u Despite political pressures to restrict trade, nations have entered into a variety of international agreements and organizations.

59. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 59 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.

60. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 60 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.

61. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 61 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.

62. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 62 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).

63. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 63 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.

64. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 64 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.

65. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 65 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.

66. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 66 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.

67. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 3 - 67 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

68. 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