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Studied by 40 peopleChapter 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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