Chapter 4
The U.S. Economy:
Private and Public
Sectors
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 revenue
4-2
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
Income By Function Performed
0
National Income Received (Percent)
10
20
30
40
50
60
Wages &
Salaries
71%
Rents
1%
Interest
Proprietor’s
Income
Corporate
Profits
70
5%
9%
14%
Source: Bureau of Economic Analysis
4-4
Personal Distribution of Income
2006
Income Group (Households)
0
Lowest
20%
Second
20%
Middle
20%
Fourth
20%
Highest
20%
Personal Income Received (Percent)
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
• Sole proprietorship
• Partnership
• Corporation
20%
Corporations
8%
Partnerships
Corporations
84%
Partnerships
11%
72% Sole Proprietorships
Sole Proprietorships
Percentage of Firms
5%
Percentage of Sales
Source: U. S. Census Bureau
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
Resource
Market
Expenditures
Resources
Goods &
Services
Businesses
Goods &
Services
Government
Net Taxes
Households
Net Taxes
Expenditures
Goods &
Services
Product
Market
4-17
Government Finance
• Government purchases
• Government transfers
Percentage of U.S. Output
35
30
27%
25
Government
Transfer
Payments
32%
5%
13%
22%
19%
20
15
10
Government
Purchases
5
0
1960
2007
4-18
Government Revenue
Total Tax Revenue, Approximate Percentage
of GDP, 2007
10
20
30
40
50
Sweden
Denmark
Finland
France
Italy
Germany
United Kingdom
Canada
Australia
United States
Japan
South Korea
58
55
51
51
46
43
42
40
35
34
33
32
Source: Organization for Economic Cooperation and Development
4-19
Federal Expenditures
Percentage of total expenditure ($2,731 billion), 2007
0
10
20
30
Pensions &
Income Security
50
34%
National
Defense
21%
24%
Health
Interest on the
Public Debt
40
9%
Source: U. S. Office of Management and Budget
4-20
Federal Tax Revenues
Sources of total tax revenue ($2,568 billion), 2007
0
10
20
Personal
Income Tax
50
34%
Corporate
Income Taxes
All
Other
40
45%
Payroll
Taxes
Excise
Taxes
30
14%
3%
4%
Source: U. S. Office of Management and Budget
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
• Sales & Excise Taxes
73%
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
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•
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•
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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
•
•
•
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•
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•
•
•
•
•
•
•
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•
•
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
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The United States
in the Global
Economy
4-29