chapter 3 the american economy in a global setting

Chapter 3

The American Economy in a Global Setting

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 3-2

“What Goes Around Comes Around”

• When firms prosper, so do households. When households struggle, so do firms.

• What are the economic forces that connect the well-being of households and firms?


Chapter Objectives

• After studying chapter 3, you will know: How households and firms are connected

by a circular flow of economic activity

How the product and resource markets connect households and firms

What role the government plays in the economy


Chapter Objectives (cont’d)

What role financial markets play in the economy

How imports and exports affect the circular flow of economic activity


The Circular Flow of Economic Activity

• Households and firms interact so closely that the well-being of one depends on the well-being of the other.

• This interaction is represented by the circular flow model.


Figure 3.1 The Circular Flow of Economic Activity


Households and Firms: The Product Market

• Households purchase goods and services from firms in product markets. Spending flows from households to firms.


Households

• Characteristics: One-fourth are headed by single

individuals. About half are headed by two parents. They are aging. They are geographically mobile.


Firms

• Firms take on many different forms: Sole Proprietorships

•Only one owner

Partnerships•Several owners pool their resources.

Corporations•Sell ownership in the form of stock


Figure 3.2 The Changing Pattern in U.S. Production Between 1947 and 2004


Changes in the U.S. Economy

• Major trends: The emergence of the service sector

•Between 1947 and 2003 there has been explosive growth in:

Legal services Health services Social services

Firm to firm transactions•Represent 14% of purchases in

product markets


Households and Firms: The Resource Market

• Firms hire factors of production from households in resource markets. Income flows from firms to households.


Exchange in the Resource Market

• Income takes the form of payments to: Labor, which earns wages, salaries, and

other compensation

Landowners, who earn rent

Capital, which earns interest

Entrepreneurial skill, which earns profit

•Proprietor's income and corporate profits


Figure 3.3 Sources of Incomein the United States Economy in 2004


Using the Circular Flow

• The circular flow model provides important insight into the economy and public policy. Households and firms—and their economic

health—are linked together by flows of spending and income.


The Government Sector of the Economy

• The government also affects the circular flow of economic activity. Direct effects:

• Adding to or taking from the flow of income

Indirect effects:• Purchasing goods and resources in markets


Levels of Government and the Circular Flow

• Local Government Collects property taxes Provides parks, museums, schools, police protection

• State Government Collects sales taxes Provides roads and school systems

• Federal Government Collects income taxes Pays transfer payments Provides national defense and interstate highways


Government Spending, Government Revenue, and the Circular Flow

• Government adds to incomes by providing transfer payments. A shift of funds from one group to another Do not involve exchange or transactions An injection into the circular flow


Government Spending, Government Revenue, and the Circular Flow (cont’d)

• The government takes away from the flow of income through taxes. A leakage from the circular flow


Government Spending, Government Revenue, and the Circular Flow (cont’d)

• Government spending refers to the government’s transactions in product and resource markets.


Spending, Taxes, and the Budget Deficit

• A federal budget deficit occurs when the government spends more money than it takes in. Financed by selling securities

• Conversely, a federal budget surplus occurs when tax revenues exceed government spending.


The Financial Sector

• Households also save some of their income. A leakage from the circular flow

• Firms require funds to buy capital.

• The financial sector brings savers and borrowers together to recycle funds into the economy.


The International Sector of the Economy

• Up to this point, we have looked at a closed economy. Based on the assumption that households and

firms don’t engage in international trade

• An open economy is an economy that does engage in international trade.


Trade and the Circular Flow

• Imports are goods that are purchased from foreign producers. A leakage from the circular flow.

• Exports are goods that are produced domestically and sold to foreign buyers. An injection into the circular flow.


Trade and the Circular Flow (cont’d)

• The difference between exports and imports is called net exports. Trade Surplus Trade Deficit


Table 3.1 U.S. Exports and Imports in 2004 by Product Group (in Billions of Dollars)


Life Lessons

• No economy is an island. The well-being of nations is closely linked

through the international sector of each nation's economy.


Strategy and Policy

• Unexpected Victims of Taxation Who could complain about taxing the yacht

industry, an industry that caters to the rich and powerful?

Many unskilled workers lost their jobs!


Summary

• The Circular Flow of Economic Activity Income cycles from households to firms and

back again.

• Households and Firms: The Product Market Households exchange money for goods and

services from firms.

• Households and Firms: The Resource Market Firms pay income to households in exchange for

factors of production.


Summary (cont’d)

• The Government Sector of the Economy Governments enter the flow through taxes

and spending.

• The Financial Sector of the Economy The financial sector connects savers

and borrowers.

• The International Sector of the Economy Imports are a leakage while exports are

an injection.

chapter 3 the american economy in a global setting

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wellbeing of households

resource market firms

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households characteristics

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