The U.S. Economy: Private and Public Sectors

Chapter 4

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives

• U.S. household and business facts

• The corporate form of business organization

• Principle agent problem• The economic role of

government • Government spending and

sources of revenue4-2

Household Income

• Functional distribution of income

–Types of income–Wage, rent, interest, profit

• Personal distribution of income–Division among households by

quintile

4-3

Functional Distribution of Income 2007

Wages & Salaries

Rents

Interest

Proprietor’sIncome

CorporateProfits

Inco

me

By

Fu

nct

ion

Per

form

edNational Income Received (Percent)

0 10 20 30 40 50 60 70

71%

1%

5%

9%

14%Source: Bureau of Economic Analysis

4-4

Personal Distribution of Income 2006

Lowest20%

Second20%

Middle20%

Fourth20%

Highest20%

Inco

me

Gro

up

(H

ou

seh

old

s)Personal Income Received (Percent)

0 10 20 30 40 50 60

3.4%

8.6%

14.5%

22.9%

50.5%Source: Bureau of the Census

4-5

Households as Spenders

• Uses of household income?

• Personal taxes (13%)

• Personal saving (1%)

• Personal consumption (86%)–Durables (11%)

–Nondurables (29%)

–Services (60%)4-6

The Business Population

• Plant

• Firm

• Industry

• Multiplant firms

• Vertically integrated

• Conglomerates

4-7

Domestic Output

Percentage of Firms Percentage of Sales

Sole Proprietorships

Partnerships

Corporations

Sole Proprietorships

Partnerships

Corporations

72%

8%

20%

5%

11%

84%

Source: U. S. Census Bureau

• Sole proprietorship• Partnership• Corporation

4-8

Advantages of Corporations

• Methods of finance–Stocks

–Bonds

• Limited liability

• Hiring of specialists

• Unlimited lifetime

4-9

Principal-Agent Problem

• Potential disadvantage of corporations

• Stockholders are principals

• Executives are agents

• Conflict of interest?

4-10

The Public Sector

• Federal, state, and local government

• Role of the government in the economy?

4-11

Government’s Role

• Provide the legal structure–Set the laws we live by

• Maintain competition–Monopoly and antitrust laws

• Redistribute income–Transfer payments–Market intervention–Taxation

4-12

Government’s Role

• Reallocating resources–Market failure

–Negative externality

–Positive externality

–Public goods

4-13

Correcting for Externalities

• Negative externalities–Legislation

–Specific taxes

• Positive externalities–Subsidies

–Government provision of goods

4-14

Types of Goods

• Private goods–Rival and excludable

• Public goods–Nonrival–Nonexcludable–Free-rider problem

• Quasi-public goods • The reallocation process

4-15

Government’s Role

• Promoting stability–Unemployment–Inflation

• A qualification–Politics–Too much or too little

regulation–Inefficiency

4-16

The Circular Flow Revisited

ResourceMarket

ProductMarket

Businesses HouseholdsGovernment

Goods & Services

Goods & Services

Net Taxes Net Taxes

Expenditures

Expenditures Goods & Services

Resources

4-17

Government Finance• Government purchases• Government transfers

35

30

25

20

15

10

5

0

Per

cen

tag

e o

f U

.S. O

utp

ut

1960 2007

GovernmentPurchases

GovernmentTransfer

Payments

22%

5%

19%

13%

27%

32%

4-18

Government Revenue

SwedenDenmark

FinlandFrance

ItalyGermany

United KingdomCanada

AustraliaUnited States

JapanSouth Korea

10 20 30 40 50

Source: Organization for Economic Cooperation and Development

5855

5151

464342

40

3534

3332

Total Tax Revenue, Approximate Percentage of GDP, 2007

4-19

Federal Expenditures

0 10 20 30 40 50

Pensions &Income Security

NationalDefense

Health

Interest on thePublic Debt

Source: U. S. Office of Management and Budget

34%

21%

24%

9%

Percentage of total expenditure ($2,731 billion), 2007

4-20

Federal Tax Revenues

0 10 20 30 40 50

PersonalIncome Tax

PayrollTaxes

CorporateIncome Taxes

ExciseTaxes

Source: U. S. Office of Management and Budget

45%

34%

3%

4%All

Other

14%

Sources of total tax revenue ($2,568 billion), 2007

4-21

Personal Income Tax

• Progressive tax rates–Brackets of income

• Marginal tax rate

• Average tax rate

4-22

State Finances

Primary Revenues• Sales & Excise Taxes (47%)• Personal Income Taxes (35%)• Corporate Income Taxes

& License Fees (18%)

4-23

State Finances

Primary Expenditures• Education (36%)• Public Welfare (28%)• Health & Hospitals (7%)• Highways (7%)• Public Safety (4%)• Other (18%)

4-24

Local Finances

Primary Revenues• Property Taxes 73%• Sales & Excise Taxes 17%

Primary Expenditures• Education 44%• Welfare, Health & Hospitals 12%• Public Safety 11%• Housing, Parks, & Sewers 8%• Streets & Highways 5%

4-25

Financing Social Security

• Demographic changes• Long-run shortfall in funding• Pay-as-you-go plan• Trust fund withdrawals• Trust fund exhausted in 2041• Benefit reductions? • Tax revenue increases?

4-26

Financing Social Security

• Possible solutions–Stock & bond investments–Payroll tax increases–Individually directed accounts –Privately owned and managed

accounts

• Consensus difficult

4-27

Key Terms • functional distribution of income• personal distribution of income• durable goods• nondurable goods• services• plant• firm• industry• sole proprietorship• partnership• corporation• stock• bond• limited liability• principal-agent problem

• monopoly• externality• negative externalities• positive externalities• public goods• free-rider problem• quasi-public goods• government purchases• transfer payments• personal income tax• marginal tax rate• average tax rate• payroll taxes• corporate income tax• sales and excise taxes• property taxes 4-28

Next Chapter Preview…

The United States in the Global Economy

4-29