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 • • • • • • • • • • • • • • • 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