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The U.S Economy: Private and Public Sectors

The U.S Economy: Private and Public Sectors. Chapter 4 (Mc Connell and Brue). Announcements. Quiz on Sunday 14 th Feb Presentation Group 1 on Friday 19 th Feb. Chapter Objectives. Important facts about U.S households and U.S businesses

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The U.S Economy: Private and Public Sectors

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  1. The U.S Economy: Private and Public Sectors Chapter 4 (Mc Connell and Brue)

  2. Announcements • Quiz on Sunday 14th Feb • Presentation Group 1 on Friday 19th Feb

  3. Chapter Objectives • Important facts about U.S households and U.S businesses • The problem that arises when corporate owners and their managers have different interests • Economic Role of government in the economy • Categories of government spending and sources of government revenues

  4. Households as Income Receivers • 113 Million households in US • Act as suppliers of economic resources • Major spenders in the economy • Income received by households can be categorized into how it is earned and how it is divided

  5. Functional Distribution of Income Indicates how the nations earned income is apportioned among: • Wages • Rents • Interest • Profits

  6. Functional Distribution of Income-2005 National Income Received (Percent) 0 10 20 30 40 50 60 70 71% Wages & Salaries 1% Rents Income By Function Performed 5% Interest 9% Proprietor’s Income 14% Corporate Profits Source: Bureau of Economic Analysis

  7. Personal Distribution of Income-2004 • Indicates how nation’s money income is divided amongst individual households Personal Income Received (Percent) 0 10 20 30 40 50 60 Lowest 20% 3.4% Second 20% 8.7% Income Group (Households) Middle 20% 14.7% 23.2% Fourth 20% 50.1% Highest 20% Source: Bureau of the Census

  8. Households as spenders • Personal Taxes: Personal Income tax takes up the largest component of personal taxes. (12%) • Personal Savings: -Saving is that part of after tax income that is not spent (bank accounts, mutual funds) • Reasons for saving: -Security and speculation • Dis-saving • Personal consumption expenditure (88%)

  9. Households as Spenders Household Uses of Income-2005 Household Income Expended (Percent) 0 10 20 30 40 50 60 70 80 90 12% Personal Taxes 0% Personal Saving Income Group (Households) 88% Personal Consumption Consumption Divided Between… Composition of Consumption 29% 12% 59% Services Nondurable Goods Durable Goods Source: Bureau of Economic Analysis

  10. Review • Functional Distribution • Personal Distribution • Saving • Consumer Spending

  11. The Business Population • Plant: physical establishment that performs one or more functions in fabricating and distributing goods and services • Firm: Business organization that owns and operates the plant • Industry: Group of firms that produce the same, or similar, products

  12. Types of firms • Multi-plant firms: Several plants performing the same function • Vertically integrated: Own plants that perform different functions in various stages of the production process • Conglomerates: Plants that produce products in several industries

  13. Legal Forms of Businesses • Sole proprietorship: owned and operated by one person • Partnership: 2 or more individuals agree to own and operate a business together • Corporation: Legal creation that can acquire resources, produce and sell products, incur debts etc. (distinct and separate from individual stockholders)

  14. Legal Forms of Business Domestic Output by Business Type 20% Corporations Partnerships 8% 84% Corporations 72% Sole Proprietorships 11% Partnerships 5% Sole Proprietorships Percentage of Firms Percentage of Sales Source: U. S. Census Bureau

  15. Advantages of Corporations • Most effective form of business to raise capital • Common Stock: Share in ownership and dividends declared • Corporate bond: No ownership , pays the holder a fixed amount (example of a bond) • Why do individuals invest in corporations? • Limited Liability • Easily expand scope of activities and benefit • Permanence: Long range planning & growth

  16. The Principal-Agent Problem • Sole proprietorship and partnerships: owners have direct control over the assets • Corporations hire managers • Principals : Stockholders • Agents: Managers • Conflict: Maximum profits and Stock price vs power , prestige, pay

  17. Review • Plant, firm and industry • Legal forms of business • Advantages of corporations • Principal –agent problem

  18. The Public Sector: Governments Role • Providing the Legal Structure -Legal framework and services for a market economy to operate efficiently -Rights of property ownership , making and enforcement of contracts -Increase volume and safety of exchange : better allocation and specialization of resources -MC and MB of intervention

  19. The Public Sector: Governments Role • Maintaining Competition -Essential for market system ( consumer sovereignty) -Monopoly: Charge higher than competitive price -Natural Monopolies: Single Seller can achieve lowest possible costs -Antitrust laws

  20. The Public Sector: Governments Role • Redistributing Income -Market system redistributes income inequitably -Methods of redistribution: -Transfer payments -Market intervention -Taxation -Benefits and costs

  21. The Public Sector: Governments Role • Reallocating Resources -A market failure occurs when the market: a)Produces wrong amounts of certain goods b)fails to allocate resources to production of certain goods -Externalities: Occur when some of the cost or benefit of a good are passed onto someone other than the buyer or seller

  22. The Public Sector: Governments Role • Negative Externalities : Production or consumption costs inflicted on third party without compensation -over allocation of resources (supply) • Solution: internalize cost -Legislation : forces offenders to bear cost -Specific taxes: Tax confined to a particular product

  23. The Public Sector: Governments Role • Positive Externalities: benefits to other producers or consumers (examples) -Demand curve lies farther to left than it would if all benefits accounted for -Too little produced, under allocation -Solutions: a)Subsidize consumers b)Subsidize producers c)Provision of goods via government (usually when externality is large)

  24. The Public Sector: Governments Role • Public Goods and Services -Private goods produced through market system (rivalry and excludability) -Public goods a)Non rivalry: everyone can simultaneously benefit b)Non excludabaility : one persons benefit does not reduce benefit available to others

  25. The Public Sector: Governments Role • Free Rider Problem: benefit without contributing to cost -Government provides for these goods and finances through taxation • Quasi Public Goods : Goods and services that can be produced and delivered in a way that exclusion is possible e.g. Highways • Reallocation process:Taxation to reduce demand and free up resources for production of public goods

  26. The Public Sector: Governments Role • Promoting Stability • Unemployment: Can occur when private spending is too low. Government can increase government spending or reduce taxes • Inflation: Spenders try to buy more than economy’s capacity. Government can decrease government spending or increase taxes

  27. Review • Ways of redistribution • Negative and positive externality • Public goods

  28. The Circular Flow Resource Market Money Income Costs Input Factors Resources Expenditures Resources Goods & Services Goods & Services Businesses Government Households Net Taxes Net Taxes Goods & Services Expenditures Goods & Services Goods & Services Product Market Consumption Revenue

  29. Government Finance • Government Purchases are exhaustive: products purchased directly absorb resources and are part of domestic output • Transfer payments are not exhaustive: Recipients make no current contribution to domestic output

  30. Government Finance 35 30 25 20 15 10 5 0 Government Transfer Payments 31% 27% 12% 5% Percentage of U.S. Output 22% 19% Government Purchases 1960 2005

  31. GLOBAL PERSPECTIVE Government Finance Total Tax Revenue – Selected Nations Percent of Total Output-2004 10 20 30 40 50 Sweden Denmark Norway Finland France Italy United Kingdom Germany Canada Australia United States Japan South Korea 50.7 49.6 44.9 44.3 43.7 42.2 36.1 34.6 33.0 31.6 25.4 25.3 24.6 Source: Organization for Economic Cooperation and Development

  32. Federal Finance Federal Expenditures-2005 Four Stand-Out Areas of Spending 0 10 20 30 40 50 Pensions & Income Security 35% National Defense 20% 17% Health Interest on the Public Debt 7% Source: U. S. Office of Management and Budget

  33. Federal Tax Revenues-2005 Basic Revenue Sources 0 10 20 30 40 50 Personal Income Tax 43% Payroll Taxes 37% Corporate Income Taxes 13% Excise Taxes 3% All Other 4% Source: U. S. Office of Management and Budget

  34. Personal Income Tax • Taxable income (exemptions and deductions) • Progressive tax : higher percentage of income paid • Marginal Tax rate: Tax paid on each additional unit of taxable income • Average tax rate : Tax paid /Taxable income

  35. Example

  36. Other forms • Payroll Taxes: Social Security contributions • Corporate Taxes: Levied on corporations profit • Excise Taxes: Tax on commodities and purchases • State finances : Sales and excise tax, spent on education and welfare etc • Local finances : Property taxes

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