the u. s. economy: private and public sectors chapter 4

The U. S. Economy: Private and Public Sectors

Chapter 4

US Economy

• Economists divide the economy into three groups:– households– businesses– government

Households

Households

• Households are:– One or more people living together in a housing

unit, supplying the economy with labor and purchasing products

– There are about 114 million households

Several different ways to measure and compare household incomes

Households

• The Functional Distribution of Income is;- How the nation’s earned income is distributed

between the different functions (categories) of wages, profits, rents and interest.

Households

• The Personal Distribution of Income is;- How the nation’s earned income is distributed

between different households.

Households

• Households on average:– Pay 13% of their income in personal taxes

– Save 1% of their income

– Spend 86% of their income

Households

• Households save:– For security – to have income in retirement, in

case of emergencies, to pay for college

– For speculation – to have more money in the future

Households

• Household income, savings and consumption are directly related:

– The higher the income, the more people spend– The higher the income, the more people save

Businesses

Businesses

• Businesses are:– An organization, usually in existence to

produce a profit for owners, which combines labor, capital and other resources to produce products.

Businesses

• Plant– A physical establishment

• Firm– A business organization that owns and operates

plants

• Industry– A group of firms that produce the same or

similar products

Businesses: Types of Ownership

• Sole proprietorship– A single owner

• Partnership– Two or more owners

• Corporation– A legal entity that can perform the functions of

any business entity. Owned by stockholders

Businesses: Advantages of Corporations

• Limited liability for stockholders– They don’t risk anything except the value of

their stocks

• Ability to raise funds– Large companies find it easier to raise money

• Political and economic power– Large corporations can alter the marketplace, or

influence government, to meet their desires

The Role of the Government

Government

• Notice that the emphasis is on the minimal role government plays.

• For some people even this little is too much.

• For others, the government can and should do more.

Government Functions

• Provide the legal structure

• Maintain competition

• Redistribute income

• Correct market failures

• Promote stability

Government: Legal Structure

• The government should provide the legal structure for the effective functioning of the capitalist (market) system.

• This includes courts and police to fight crime and enforce contracts.

Government: Legal Structure

• The legal structure also includes a state strong enough to pass laws and enforce contracts.

• Russia is the example of a state that is too weak: the mafia took over the country.

Government: Maintain Competition

• The most efficient economic system is competition. But there appears to be a natural tendency for competition to end and monopolies to emerge.

• Government should provide the legal structure to fight monopolies.

Government: Redistribute Income

• All democratic governments redistribute income, as a result of popular beliefs about fairness, justice, and lobbying for special groups.

Government: Correcting Market Failures

• Market failures take place when firms produce the wrong amount of certain products

• Or when markets fail to allocate resources to produce necessary products.

Government: Correcting Market Failures

• The first leads to spillovers

• The second involves public goods

Spillovers

Correcting Market Failures:Spillovers

• Spillovers take place when costs or benefits of an economic activity are passed on to parties who are neither buyers nor sellers in that activity.

Correcting Market Failures:Negative Spillovers

• A negative spillover occurs when economic activities inflict costs on third parties.

• Examples of negative spillovers include all types of pollution.


• In the case of spillovers, the government needs to find some mechanism to either pass the costs onto offending firms, or get them to change their behavior.


• Governments can raise taxes on the polluting firms.

• Or it can pass laws to force the companies to change their behavior

Correcting Market Failures:Positive Spillovers

• A positive spillover occurs when economic activities benefit someone in addition to the buyer and seller of a product.

• Examples of positive spillovers include all types of education, libraries, immunization shots.


• In the case of positive spillover, the market system doesn’t produce enough of the product.


• In the case of positive spillovers, the government needs to increase demand, or increase supply, or produce the product itself.


• Governments can raise taxes on the polluting firms.

• Or it can pass laws to force the companies to change their behavior

Public Goods

Correcting Market Failures:Public Goods

• Public goods are products that are economically and socially justifiable, but which no private firm will produce.

Correcting Market Failures: Private Goods

• Private goods

– Are produced by firms and have two characteristics

• Private goods have excludability and rivalry


• Excludability– Buyers who are willing and able to pay the

market price enjoy the benefits of buying the product.

– People who can’t afford the good, don’t enjoy the benefits


• Rivalry– Means when one person buys the good, no one

else can buy or use them.– If I buy a pair of jeans, no one else can buy or

use them.

Correcting Market Failures: Public Goods

• Public goods

– Are usually produced by governments and have two characteristics

• Public goods have non-excludability and non-rivalry


• Nonexcludability– People who buy the good or service benefit, but

so do people who don’t buy the product.– Street lighting, flu shots


• Nonrivalry– If I buy the product, other people can still use

it.– If I “buy” a national defense, everyone else can

enjoy the benefits as well.

Correcting Market Failures: Public vs. Private Goods

The line between public and private goods is not sharp.

It varies from one society to another, and from one time period to another.

Government:Promoting Stability

Governments should also control inflation and reduce unemployment.

Too much of either is bad for the economy, and ultimately, businesses.

Federal Finance

Government:Federal Budget

Notice the charts on page 85.

Notice how much goes to defense.

Notice how the tax structure lightly taxes corporations and the wealthy, compared to other countries.

Government:State Budgets

The primary tax revenue for states is sales and excise taxes.

the u. s. economy: private and public sectors chapter 4

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