Chapter 4: The US Economy: Private and Public Sectors

• Households are suppliers of economic resources + major spenders in the economy
• Functional distribution of income - Illustrates how the nation’s income is distributed among wages, rents, interest, and profits
    * Largest source of income for households is wages/salaries
• Personal distribution of income - How the nation’s total income is divided among individual households
    * Taxes, noncash transfers, and movement of households among categories lessens income inequality
• How households dispose of income
    * Personal taxes
    * Personal saving - Flows into bank accounts, insurance policies, bonds and stocks, mutual funds, etc.
      * More income → Usually save more
    * Personal consumption
      * Durable goods - Products with expected lives of 3 years or more
      * Non-durable goods - Products with expected lives of less than 3 years
      * Services - Work done for consumers by lawyers, barbers, doctors, etc.
• Businesses
    * Plant - Physical establishment that helps with manufacturing and distributing goods and services
    * Firm - Organization that uses resources to produce goods and services for profit
    * Industry - Group of firms that produces same, or similar, products
• Legal forms of business
    * Sole proprietorship - Business owned + operated by 1 person
      * Easy to set up + organize
    * Partnership - Business owned + operated by 2+ people; share risks, profits, and losses
    * Corporation - Distinct/separate from individual stockholders that own it; run by hired managers
      * Pools financial resources of large #s of people
      * Stock - Share in the ownership of a corporation
      * Bond - Lends money to corporation; no corporate ownership for purchaser
      * Organized stock exchanges + bond markets → Simplifies transfer of securities b/w sellers + buyers
      * Limited liability - Stockholders risk only what they paid for their stock; personal assets not at stake
      * Corporations benefit from expanding + becoming more efficient
      * Ownership can easily be transferred
    * Principal-agent problem - Interests of people managing the corporation (agents) and of the owners (principals) don’t always coincide
• The government’s role in the economy
    * Legal framework + services needed for a market economy to operate effectively
    * Legal rules that control relationships b/w businesses + consumers
    * Improves resource allocation (MB = MC)
    * Maintains competition
      * Monopoly - Single seller controls an industry
      * Natural monopoly - Only 1 seller can achieve lowest possible costs
      * High competition → Efficient production
    * Redistributes income
      * Transfer payments - Welfare checks, food stamps, unemployment compensation, etc.
      * Market intervention - Modifying prices set by market forces
      * Taxation - Takes larger proportion of income from rich
    * Reallocates resources
      * Externality - Some of the costs or benefits of a good “spill over” to 3rd parties that aren’t the buyer or seller
      * Negative externalities - Production or consumption costs that affect 3rd parties without compensation
        * Overallocation of resources
        * Corrected w/ legislation or taxes
      * Positive externalities - Production or consumption benefits that are enjoyed by 3rd parties
        * Underallocation of resources
        * Corrected w/ subsidies or government management of an industry
      * Private goods - Produced through competitive market system; rivalry + excludability
      * Public goods - Everyone can simultaneously obtain benefits; one person’s benefit does not reduce benefits available to others
      * Free-rider problem - People can receive benefits from a public good w/o paying for it
        * Unprofitable for private firms
      * Quasi-public goods - Government provides public goods and services that could include exclusion (could be provided by private firms)
      * Reallocation - Resources shifted from production of private goods to production of public + quasi-public goods
    * Uses monetary + fiscal policy to fix problems with widespread unemployment or inflation
• The government in the circular flow model
    * Makes purchases in both product + resource markets
    * Provides public goods + services to both households + businesses
    * Households + businesses forced to pay taxes
• Government finance
    * Government purchases - Products purchased directly absorb resources + are part of domestic output
    * Transfer payments - Don’t directly absorb resources or create output; recipients don’t contribute to domestic output in return for them
• Federal finance
    * Federal spending
      * Pensions + income security
      * National defense
      * Health
      * Interest on the public debt
• Federal tax revenues
    * Personal income tax - Levied on taxable income
      * Progressive tax - People w/ higher incomes pay a larger percent of their incomes
    * Marginal tax rate - Rate at which the tax is paid on each additional unit of taxable income
    * Average tax rate - Total tax paid divided by total taxable income
      * A progressive tax’s average rate rises as income increases
    * Payroll taxes - Taxes based on wages + salaries used to finance compulsory federal programs
    * Corporate income tax - Levied on a corporation’s profit
    * Sales and excise taxes - Taxes on commodities or purchases
• State and local finance
    * State finances
      * Primary source of tax revenue for state gov’ts is sales + excise taxes
      * State personal income taxes
      * Corporate income taxes + license fees
    * Local finances
      * Property taxes - Make up 72% of local governments’ tax revenue
      * Revenue from intergovernmental grants from federal + state gov’ts

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