The Sources of Household Income

1. The Sources of Household Income • Households derive their incomes from three basic sources: • from wages or salaries received in exchange for labor • from property(real and financial)—profits, interest, dividends, and rents • from government - transfer payments

2. The Distribution of Income • Economic income is the amount of money a household can spend during a given period without increasing or decreasing its net assets. • Wages, salaries, dividends, interest income, transfer payments, rents, and so forth are sources of economic income.

3. Introduction to Macroeconomics • Microeconomics examines the behavior of individual decision-making units—business firms and households. • Macroeconomics deals with the economy as a whole; it examines the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices. • Aggregate behavior refers to the behavior of all households and firms together.

4. Introduction to Macroeconomics • Microeconomists generally conclude that markets work well. Macroeconomists, however, observe that some important prices often seem “sticky.” • Sticky prices are prices that do not always adjust rapidly to maintain the equality between quantity supplied and quantity demanded.

5. Macroeconomic Concerns • Three of the major concerns of macroeconomics are: • Inflation • Output growth • Unemployment

6. Government in the Macroeconomy • There are three kinds of policy that the government has used to influence the macroeconomy: • Fiscal policy • Monetary policy • Growth or supply-side policies

7. Government in the Macroeconomy • Fiscal policy refers to government policies concerning taxes and spending. • Monetary policy consists of tools used by the Federal Reserve to control the quantity of money in the economy. • Growth policies are government policies that focus on stimulating aggregate supply instead of aggregate demand.

8. The Components ofthe Macroeconomy • Everyone’s expenditure is someone else’s receipt. Every transaction must have two sides.

9. The Three Market Arenas • Households, firms, the government, and the rest of the world all interact in three different market arenas: • Goods-and-services market • Labor market • Money (financial) market

10. The Three Market Arenas • Households and the government purchase goods and services (demand) from firms in the goods-and services market, and firms supply to the goods and services market. • In the labor market, firms and government purchase (demand) labor from households (supply). • The total supply of labor in the economy depends on the sum of decisions made by households.

11. The Three Market Arenas • In the money market—sometimes called the financial market—households purchase stocks and bonds from firms. • Households supply funds to this market in the expectation of earning income, and also demand (borrow) funds from this market. • Firms, government, and the rest of the world also engage in borrowing and lending, coordinated by financial institutions.

12. Gross Domestic Product • Gross domestic product (GDP) is the total market value of all final goods and services produced within a given period by factors of production located within a country.

13. Final Goods and Services • The term final goods and services in GDP refers to goods and services produced for final use. • Intermediate goods are goods produced by one firm for use in further processing by another firm.

14. Real GDP, 1900-2002

15. Exclusions of Used Goodsand Paper Transactions • GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced. (used goods and paper transactions) • GDP excludes output produced abroad by domestically owned factors of production (Ford making cars in Mexico) This is GNP

16. Calculating GDP GDP can be computed in two ways: • The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period. • The income approach: A method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods.

17. The Expenditure Approach Expenditure categories: • Personal consumption expenditures (C)—household spending on consumer goods. • Gross private domestic investment (I)—spending by firms and households on new capital: plant, equipment, inventory, and new residential structures.

18. The Expenditure Approach • Government consumption and gross investment (G) Expenditure categories: • Net exports (EX – IM)—net spending by the rest of the world, or exports (EX) minus imports (IM)

19. The Expenditure Approach • The expenditure approach calculates GDP by adding together the four components of spending. In equation form:

20. Nominal Versus Real GDP • Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. Nominal GDP includes all the components of GDP valued at their current prices. • When a variable is measured in current dollars, it is described in nominal terms.

21. GDP and Social Welfare • Society is better off when crime decreases, however, a decrease in crime is not reflected in GDP. • An increase in leisure is an increase in social welfare, but not counted in GDP. • Nonmarket and household activities are not counted in GDP even though they amount to real production. • GDP makes no value judgments (pet rocks)

22. The Underground Economy • The underground economy is the part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.

23. The Government’s Goal for the Economy • An ideal economy is one in which there is: • rapid growth of output per worker, • low unemployment, and • low inflation.

24. Recessions, Depressions,and Unemployment • A recession is roughly a period in which real GDP declines for at least two consecutive quarters. It is marked by falling output and rising unemployment. • The business cycle describes the periodic ups and downs in the economy, or deviations of output and employment away from the long-run trend.

25. Recessions, Depressions,and Unemployment • Capacity utilization rates, which show the percentage of factory capacity being used in production, are one indicator of a recession. • A depression is a prolonged and deep recession. The precise definitions of prolonged and deep are debatable.

26. Defining andMeasuring Unemployment • The most frequently discussed symptom of a recession is unemployment. • An employed person is any person 16 years old or older: • who works for pay, either for someone else or in his or her own business for 1 or more hours per week, • who works without pay for 15 or more hours per week in a family enterprise, or • who has a job but has been temporarily absent, with or without pay.

27. Defining andMeasuring Unemployment • An unemployed person is a person 16 years old or older who: • is not working, • is available for work, and • has made specific efforts to find work during the previous 4 weeks. • A person who is not looking for work, either because he or she does not want a job or has given up looking, is not in the labor force.

28. Defining andMeasuring Unemployment

29. The Discouraged-Worker Effect • The discouraged-worker effect lowers the unemployment rate. • Discouraged workers are people who want to work but cannot find jobs. They grow discouraged and stop looking for work, thus dropping out of the ranks of the unemployed and the labor force.

30. Types of Unemployment • Frictional unemployment is the portion of unemployment that is due to the normal working of the labor market; used to denote short-run job/skill matching problems.

31. Types of Unemployment • Structural unemployment is the portion of unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries.

32. Types of Unemployment • Cyclical unemployment is the increase in unemployment that occurs during recessions and depressions.

33. Types of Unemployment • The natural rate of unemployment is the unemployment that occurs as a normal part of the functioning of the economy. Sometimes taken as the sum of frictional unemployment and structural unemployment.

34. Explaining the Existence of Unemployment • Minimum wage laws set a floor for wage rates, and explain at least a fraction of unemployment.

35. Effect of Minimum Wage Legislation • Minimum wage is the lowest wage that firms are permitted to pay workers. • If the equilibrium wage in the market for unskilled labor is below the legislated minimum wage, the result is likely to be unemployment.

36. The Phillips Curve • There is a trade-off between inflation and unemployment. To lower the inflation rate, we must accept a higher unemployment rate.

37. The Benefits of Recessions • Recessions may help to reduce inflation. • Some argue that recessions may increase efficiency by driving the least efficient firms out of business and by forcing surviving firms to trim waste and manage their resources better. • Also, a recession leads to a decrease in the demand for imports, which improves a nation’s balance of payments.

38. Inflation • Inflation is an increase in the overall price level. • Deflation is a decrease in the overall price level. • Sustained inflation is an increase in the overall price level that continues over a significant period.

39. Price Indexes • Price indexes are used to measure overall price levels. The price index that pertains to all goods and services in the economy is the GDP price index. • The consumer price index (CPI) is computed each month by the Bureau of Labor Statistics using a bundle that is meant to represent the “market basket” purchased monthly by the typical urban consumer. • The consumer price index (CPI) is the most popular fixed-weight price index.

40. Price Indexes • The CPI market basket shows how a typical consumer divides his or her money among various goods and services.

41. The Consumer Price Index (CPI)

42. The Costs of Inflation • People’s income increases during inflations, when most prices, including input prices, tend to rise together. • Inflation changes the distribution of income. People living on fixed incomes are particularly hurt by inflation.

43. The Costs of Inflation • The benefits received by many retired workers, including social security, are fully indexed to inflation. When prices rise, benefits rise. • The poor have not fared so well. Welfare benefits are not indexed and have not kept pace with inflation.

44. The Costs of Inflation • Unanticipated inflation—an inflation that takes people by surprise—can hurt creditors. • Inflation that is higher than expected benefits debtors; inflation that is lower than expected benefits creditors. • The real interest rate is the difference between the interest rate on a loan and the inflation rate.

45. The Role of Government Financing, Taxes, And Spending • Each year the federal and state governments make and pass budgets. A budget is a plan for spending for the government for that year. • If the government spends more than it takes in then it is in a deficit. If the government can bring in more than it spends then it has a surplus.

46. The Budget Deficit • A government’s budget deficit is the difference between what it spends (G) and what it collects in taxes (T) in a given period: • If G exceeds T, the government must borrow from the public to finance the deficit. It does so by selling Treasury bonds and bills. In this case, a part of household saving (S) goes to the government.

47. Federal Revenues • There are 3 main sources of government revenue • Income Taxes • Payroll Taxes • Excise Taxes

48. Income Taxes • A tax on the income of people and businesses, this makes up nearly half of the federal governments revenue. • The IRS is responsible for collecting income taxes. • The deadline to file personal income taxes is April 15th.

49. Payroll Taxes • this is money that is taken out of your pay checks to fund Social Security, and Medicare, this makes up one-third of federal revenue.

50. Excise Tax • A tax on a specific good • Gasoline • Telecommunications