ECONOMIC DECISION MAKERS

LOs1. Explain the role of the

household in the economic system.

2. Identify the different types of firms and describe their roles in the economy.

3. Outline the ways governments affect their economies.

4. Outline the international influences on the economy.

Households

• Suppliers of economic resources.

• Buyers of goods and services.

• Producers of goods and services (household production).

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Where U.S. personal income comes from and where it goes

(a) Over two-thirds of personal incomein 2006 was from wages, salaries, andproprietors income

(b) Half of U.S. personal incomein 2006 was spent on services

TRANSFER PAYMENTSCash or in-kind benefits given to individuals as outright grants from the government

Cash transfers: Social security, disability, unemployment compensation, TANF.

In-kind transfers: Medicare, Medicaid, food stamps, school lunch program, subsidized housing.

Household ProductionGardening, cooking, ironing,

childcare, car repair, painting—many people do these things “in-house.”

Household production makes sense if the opportunity cost is less than market price.

The Firm

• Firms– Hire and combine resources– Produce goods and services– Maximize profit

6

Types of Firms

• Sole proprietorship– Single owner

• Partnership– Two or more owners

• Corporation– Legal entity– Shares of stock– Limited liability

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8

Number and sales of each type of firm

(a) Most firms are sole proprietorships

(b) Corporations account for most sales

The Government

• Establish & enforce rules of the game• Promote competition• Regulate natural monopolies• Provide public goods• Deal with externalities• More equal distribution of income• Full employment• Price stability• Economic growth

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ExternalitiesPrivate production and

consumption can impose costs on parties “outside

the market.” Some costs of production or consumption

are thus externalized.

Examples:

Air, water, noise pollution; cigarette smoke; acid rain; mosquitoes.

In a world where externalities occur, market forces cannot

always be relied upon to allocate resources efficiently. This creates a legitimate reason for government

regulation.

Examples of government policy aimed at externalities:

•Effluent taxes•Pollution “permits”•Subsidized vaccinations•Auto emission standards•Open burning ordinances•Smoke free workplaces

Public GoodsA good that, once produced, is available for all to consume regardless of who pays and who doesn’t; such a good is nonrival and nonexclusive.

•Public goods are subject to a free-rider problem.•Examples include lighthouses, flood control, and national defense.

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Components of Federal Spending Since 1960

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Federal Revenues by Source since 1960

Tax Principles and Tax Incidence

• Ability-to-pay tax principle• Benefits-received tax principle• Tax incidence– Proportional taxation: Flat tax (as % of income)– Progressive taxation: marginal tax rate

– Top 1% of tax filers – paid 36.9% of taxes– Top 10% of tax filers – paid 68.2% of taxes– Bottom 50% of tax fillers – paid 3% of taxes

– Regressive taxation

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By making the tax structure “progressive,” governments can make the after-tax distribution

of income more equitable (or even).

AffluentNeedy

Family

(1)

Income

(2)Spending for items subject to excise tax

(3)=

(2)/(1)

(4)

Excise Tax Paid

(5)=(4)/(1)

ATR

Greens $27,000

$16,200 .60 $1,188 4.4%

Jones 64,000 25,600 .40 1,871 2.9Lemons 270,00

040,500 .15 2,961 1.0

Assume a 7.13 percent excise tax on groceries, gasoline, cigarettes, and liquor

Moral of the story: Low income families tend to spend a greater proportion of their income on items subject to excise taxes. Hence excise taxes tend to be regressive.

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Top marginal rate on federal personal income tax since 1913

The rest of the world

•Consists of households, firms, and government units in roughly 200 sovereign foreign countries.•Foreign agents buy domestically produced goods and services. •Domestic agents buy goods and services from foreign producers.

The Global Economy

The world is more “integrated” than ever before, as measured by

the movement of resources, goods and

services between countries

Distribution of global production

Energy Sources in the World Economy

Energy Sources in the World Economy

Energy Sources in the World Economy

Exchange rates

An exchange is a price of one (national) currency

expressed in terms of another currency.

If the dollar price of the British pound is:

1.45 dollars = 1 pound

Then the pound price of the dollar is given by the reciprocal of the dollar-pound exchange rate. That is:

Pounds per dollar = pounds69.045.11