1. Chapter 5: The U.S. Economy Both the private (household & businesses) sector and the public (government) sector participate in the market economy. Households, businesses, and governments are the primary decision makers in the economy

2. Households as Income Receivers A household consists of one or more persons occupying a housing unit Ultimate suppliers of all economic resources Major spenders in the economy Categories: How income was earned How income was spent

3. Functional Distribution of Income Indicates how households earned income Wages paid to labor Rents & Interest paid to owners of property Profits paid to owners of corporations Proprietors’ income is paid as wages and as profit from business (doctors, lawyers, small business owners, farmers)

4. Households as Spenders How do households dispose of their income? 1. Personal taxes 2. Savings ( < 1%) 3. Consumption ( > 80%)

5. Personal Consumption Expenditures Spending Categories: 1. Durable Goods: products that have shelf- life of three (3) + years 2. Non-durable Goods: products that have shelf-life of less than three (3) years 3. Services: work done by consumers (> 50%) US is a service-oriented economy

6. Business Population Plant: physical establishment where production or distribution takes place Factory, farm, store Firm: business organization that owns & operates the plant(s) Legal entity Industry: a group of related firms, producing the same or similar products

7. Legal forms of business Sole Proprietorship: Owned by a single individual Partnership: Two or more individuals own & operate in a partnership agreement Corporation: Legal entity distinct from individual owners Organization is a legal person

8. Sole Proprietorship Advantages: Easy to set up Proprietor is his/her own boss Proprietor has strong incentive to operate business efficiently Disadvantages: Financial resources are limited & insufficient Proprietor has sole management functions Proprietor is subject to unlimited liability

9. Partnerships Advantages: Easy to organize Greater specialization Better access to financial resources Disadvantages: Divided authority in management Limited financial resources Continuity of partnership Unlimited liability

10. Corporations Advantages: Improved ability to raise financial capital Method of finance: Selling stocks & bonds Limited Liabilities Permanence conducive to long-run planning & growth Disadvantages: Red tape & legal expenses in obtaining charter Lends itself to abuses

11. Principal-Agent Problem Principals are stockholders Own corporation Maximize company profit & stock price Agents are hired to run corporation Desire power, prestige, & high pay Interest of agents (managers) & owners may not coincide Tying executive pay to stock price

12. The Public Sector: Government’s Role What is the government’s role in the economy? Providing legal structure Maintaining competition Redistribution of income Reallocation of resources Provide public goods & services Promote stability

13. Public v. Private Goods Private goods are produced through market Divisible Come in units small enough to be affordable for individual consumers Subject to Exclusion Principle: those unable & unwilling to pay are excluded from benefits of the product

14. Public / Social Goods Not produced by market Indivisible Not subject to Exclusion Principle Free-rider problem: People receive benefits from good without contributing to its cost Producers unable to find enough paying buyers Good is not produced voluntarily in market Must be provided by public sector, financed by taxes

15. Quasi-public Goods Have large spillover benefits Government sponsors provision, otherwise good is under-produced Medical care Education Public housing

16. Government Finance Governments spends money on purchasing goods & services and transfer payments Transfer payments have significantly grown since 1960s Social security Unemployment compensation Welfare payments

17. Federal Expenditures: Income Security National Defense Health Interest on the National Debt

18. Federal Revenues Personal Income Tax Payroll Taxes (Social Security) Corporate Taxes Sales & Excise Taxes

19. Chapter 5 Study Questions 3: Plant v. Firm v. Industry 4: Legal Business Firms 6: Government Functions 11: Private v. Public Goods