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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