ECO 2013
Chapter 4: The US Economy: Private and Public Sectors
Economic Decision Makers
 Households
o Play the starring role in a market economy.
o About 113 million households in the US alone
o Their demand for goods and services determines
what gets produced.
o Their supplies of labor, capital, natural resources,
and entrepreneurial ability to produce that output.
 Functional Distribution of Income
o Indicates how the nation’s earned income is
apportioned among wages, rents, interest, and
profits.
 Wages  Labor
 Rents  Land
 Interest  owners of property resources
 Profits  owners of businesses
Distribution of Personal Income
Interest
Rents
Profits
Self
Employment
income
Wages
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ECO 2013
Chapter 4: The US Economy: Private and Public Sectors
o Personal Distribution of Income
 Indicates how the nation’s money income is
divided among individual households.
 The top 20% of households earn over 50% of
the income in the US
Households as Spenders
 Households spend their money in one of three
categories
 Personal Taxes – 12% of their income
 Personal Savings – portion of after tax
income that is not spent.
 3% of their income but some
households dissave due to low income
causing the net savings in US to be 0%
 Security and speculation are reasons for
saving
 Personal Consumption – 88% of their income
 Households as demanders of goods and
services
 Three broad spending categories
o Durable goods – 12%
 Goods expected to last three
or more years
o Nondurable goods – 29%
 Goods such as food and
gasoline
o Services – 59%
 Businesses
o Constitute the second major part of the private
sector.
o Is a business organization that owns and operates
plants. Some firms operate only one plant, but
many own and operate several.
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Fall 2007
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ECO 2013
Chapter 4: The US Economy: Private and Public Sectors
o Types of firms
 Sole Proprietorship
 A firm with a single owner who has the
right to all profits and who bears
unlimited liability for the firm’s debts
 Partnership
 A firm with multiple owners who share
the firm’s profits and bear unlimited
liability for the firm’s debts.
 Corporation
 A legal entity owned by stockholders
whose liability is limited to the value of
their stock.
 Distinct and separate from the individual
stockholders who own it.
 Advantages
o Certain advantages of the
corporate form of business
enterprise have catapulted it into a
dominant sales and profit position
in the US
o The most effective form of
business organization for raising
money to finance the expansion of
its facilities and capabilities
o A common stock represents a
share in the ownership of a
corporation
o Corporations provide limited
liability to owners who risk only
what they paid for their stock.
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Fall 2007
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ECO 2013
Chapter 4: The US Economy: Private and Public Sectors
The Public Sector: Government’s role
 The economic role of the public sector are extensive
 Levels of Government
o Federal
o State
o Local
 Role of Government
o Providing legal structure
 Government provides the legal framework
and the services needed for a market
economy to operate effectively.
 Sets the legal status of business enterprises
 Ensures the rights of private ownership
 Allows the making and enforcement of
contracts.
 Establishing and enforcing the rules of the
game
 Government intervention is presumed to
improve the allocation of resources
 By supplying a medium of exchange,
ensuring product quality, defining
ownership rights, and enforcing
contracts, the government increases the
volume and safety of exchange.
o Promoting competition
 Competition is the basic regulatory
mechanism in the market system
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Chapter 4: The US Economy: Private and Public Sectors
 It is the force that subjects producers and
resource suppliers to the dictates of
consumer sovereignty
o Regulating natural monopolies
 Monopoly – sole producer of a product for
which there are no close substitutes
 Natural monopoly – one firm that can serve
the entire market at a lower per unit cost
than can two or more firms
o Redistributing income
 Transfer payments
 Form of welfare checks and food
stamps, provide relief to the destitute,
dependent, disabled, and older citizens
 Unemployment compensation
 Market intervention
 by acting to modify the prices that are
or would be established by market
forces
 Taxation
 Government has used personal income
tax to redistribute income from the rich
to the poor
o Reallocating Resources
 Market Failure
 Occurs when the competitive market
system
o Produces the wrong amounts of
certain goods and services
 Externalities or spillovers
o Fails to allocate any resources
whatsoever to the production of
certain goods and services whose
output is economically justified.
 Public Goods
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Chapter 4: The US Economy: Private and Public Sectors
Externalities:
 An externality occurs when some of the costs or
the benefits of a good are passed to or spill over
to someone other than the immediate buyer or
seller.
 Negative Externalities
 Production or consumption costs inflicted on
a third party without compensation
 Environmental pollution
 Correcting for Negative Externalities
 Legislation
o Prohibiting or limiting the action
o The idea is to force potential
offenders under the threat of legal
action, to bear all the costs
associated with production.
 Specific Taxes
o A less direct action is based on the
fact that taxes are a cost and
therefore a determinant of a firm’s
supply curve.
o Government might levy a specific
tax on the production
o Positive Externalities
 Sometimes externalities appear as benefits to
other producers or consumers.
 These are uncompensated spillovers accruing
to third parties or the community at large
 Immunization of all citizens
 Education
 Correcting for Positive Externalities
 Underallocation of resources associated
with spillover benefits
 Subsidize consumers
o Provide financial aid for education
 Subsidize suppliers
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Chapter 4: The US Economy: Private and Public Sectors
o Repay hospitals for vaccines
 Provide goods via government
Public Goods
 Private good – a good that is both rival in consumption
and exclusive
 Public good – a good that once produced is available for
all to consume regardless of who pays
o Non-rivalry and non-excludability
o Everyone can simultaneously obtain the benefit
from a public good
o Inability to exclude creates a free rider problem
 In which people can receive benefits from a
public good without contributing to its costs
o Example: National defense
o Must be provided by government
 Governments’ Structure and Objectives
o
o Federal System
 Meaning that responsibilities are shared
across levels of government
 Federal
o National security
o Economic stability
o Market competition
 State
o Public higher education
o Prisons
o Transportation
o welfare
 Local
o Primary and secondary education
o Police and fire protection
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Chapter 4: The US Economy: Private and Public Sectors
 Size of government
 1930 – 10% of production went to
government
 2004 – 36% of production went to
government
o Government Purchases and Transfers
 Government purchases
 Are exhaustive, they directly absorb
resources and are part of the domestic
output
 Purchases of goods and services to
operate government
 Transfer payments
 Non-exhaustive, they do not directly
absorb resources or create output.
o Federal Expenditures
 Pensions and income security
 Social security, unemployment
 35%
 National defense
 20%
 Health
 Medicare and Medicaid
 21%
 Interest on the public debt
 7%
 http://www.brillig.com/debt_clock/
 Debt is
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Chapter 4: The US Economy: Private and Public Sectors
o Sources of Government Revenue
 Taxes provide the bulk of revenue at all
levels of government
 Federal government relies primarily on the
individual income tax,
 State government rely on income and sales
taxes
 Local government relies on property taxes
 Taxes are divided as:
 Personal income tax – 43%
 Excise taxes – 3%
 Corporate income tax – 13%
 Payroll taxes – 37%
o Tax Principles and Tax Incidence
 Structure of tax system is often justified on
the basis of one of two general principles:
o Ability to pay principle
 Those with a greater ability to
pay such as those with a
higher income or those who
own more property should
pay more taxes
o Benefits received tax principle
 Those who receive more
benefits from the
government program
funded by a tax should
pay more taxes
 Tax incidence
 The distribution of tax burden among
taxpayers, who ultimately pays the tax
o Proportional tax
 The tax as a percentage of
income remains constant as
income increases
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ECO 2013
Chapter 4: The US Economy: Private and Public Sectors
 Flat tax
o Progressive tax
 The tax as a percentage of
income increases as income
increases
o Marginal tax rate
 The percentage of each
additional dollar of income
that goes to the tax
o Regressive taxation
 The tax as a percentage of
income decreases as income
increases
Level of
Government
Federal
Services Provided
National defense
Transfer payments
Transfers to states
State
Public transportation
Welfare
Higher education
Local
Police and fire
protection
Primary and
Secondary education
Types of Taxes:
 Personal income tax
o Tax on the earnings of individuals
o Progressive tax
o All but six states have it
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Taxes Imposed
Personal income tax
Corporate income
tax
Excise taxes
Personal income tax
Corporate income
tax
Excise taxes
Sales taxes
Excise taxes
Property taxes
ECO 2013
Chapter 4: The US Economy: Private and Public Sectors
Rates below:
Single taxpayer
If taxable income is over-- But not over--
The tax is:
$0
$7,150
10% of the amount over $0
$7,150
$29,050
$715.00 plus 15% of the amount over 7,150
$29,050
$70,350
$4,000.00 plus 25% of the amount over 29,050
$70,350
$146,750
$14,325.00 plus 28% of the amount over 70,350
$146,750
$319,100
$35,717.00 plus 33% of the amount over 146,750
$319,100
no limit
$92,592.50 plus 35% of the amount over 319,100
Married taxpayer
If taxable income is over-- But not over--
The tax is:
$0
$14,300
10% of the amount over $0
$14,300
$58,100
$1,430.00 plus 15% of the amount over 14,300
$58,100
$117,250
$8,000.00 plus 25% of the amount over 58,100
$117,250
$178,650
$22,787.50 plus 28% of the amount over 117,250
$178,650
$319,100
$39,979.50 plus 33% of the amount over 178,650
$319,100
no limit
$86,328.00 plus 35% of the amount over 319,100
 Corporate income tax
o Tax on earnings of corporations
o Progressive tax
o Federal and state
If taxable income (line 30, Form 1120, or line 26, Form 1120-A) on
page 1 is:
Over—
But not over—
Tax is:
Of the amount over—
15%
$0
$50,000
$0
$ 7,500 + 25%
50,000
75,000
50,000
13,750 + 34%
75,000
100,000
75,000
22,250 + 39%
100,000
335,000
100,000
113,900 + 34%
335,000
10,000,000
335,000
3,400,000
+ 35%
10,000,000
15,000,000
10,000,000
15,000,000
18,333,333 5,150,000 + 38%
15,000,000
35%
18,333,333
----0
 Sales tax
o Tax on purchases of goods and services
o Some services excluded
o Some goods excluded
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Chapter 4: The US Economy: Private and Public Sectors
o Flat rate
o State and local governments
 Property taxes
o Tax on the value of real property
o Tax on the value of tangible property
o Flat rate
o Local governments
 Excise taxes
o Tax on the consumption of specific goods
o Called sin taxes
o Gasoline, alcohol, tobacco
o All levels of government
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