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U.S. Private and Public Sectors
Lesson 4

U.S. Private Sector

1. U.S. Households

  • Functional Distribution of Income (2005) - where a household's income comes from
    • Income comes from wages/salary, interest, rent, profits

Personal Income Distribution

  • Personal Distribution of Income (2004) - which group earns household's income
    • Divide income earners into 5 classes (quintiles)
      • Lowest 20% are the poor
      • Highest 20% are the rich

Personal Income by Quintiles

  • Household spending - where does a household's money go
    • Disposable income - income after taxes are taken out
      • Household can spend and/or save disposable income
    • Expenditures
      • Durable goods - products that have a life of 3 years or more
        • Automobiles, furniture, computers, etc.
      • Nondurable goods- products that have a life of 3 years or less
        • Food, clothing, and gasoline
      • Services - a service provided to the consumers
        • Attorneys, barbers, doctors, hotels, etc.

Pie Chart for Household Expenditures

2. U.S. Businesses

  • Definitions
    • Plant - a physical place such as factory, firm, mine, store, or warehouse
    • Firm - a business that owns the capital
    • Industry - a firm or group of firms that produce a similar product for a market

Legal Forms of Business

(i) Sole Proprietorship - owned by a single individual

  • Owner liable for his business debts
  • Business is dissolved when owner dies
  • Accounts for 72% of business firms
  • Collects 5% of the business revenue
    • Farms
    • Grocery stores
    • Restaurants

(ii) Partnership - owned by a two or more persons acting as co-owners

  • High risk, because all partners are responsible for debts incurred by 1 partner
  • If one partner dies, then business has to be reorganized
  • Accounts for 8% of business firms
  • Collects 11% of the business revenue
    • Law firms
    • Accounting firms

(iii) Corporation - owned by stockholders and is a separate legal entity

  • Advantages
    • Limited liability - if corporation bankrupts, the creditors cannot sue the stockholders The stockholders only lose the value of their stocks
    • Ownership can be easily transferred
      • Easy to buy and sell stock
      • stock - a share of ownership in a corporation
      • Theoretically, a corporation can live forever
    • The stockholders elect the board directors who in turn select the managers to run the corporation
    • Corporations can issue a large amount of stocks and bonds
      • bonds- corporation borrows money in its name
      • Corporations can accumulate a large amount of capital
  • Problems
    • Corporations can merge and buy other corporations
      • vertically integrated - firms owns or controls all levels of processing
        • Many oil companies extract, transport, refine, and sell petroleum to consumers
      • horizontally integrated (mutliplant) - firm controls production and sales across a market
        • Microsoft controls over 95% of operating systems out there
      • conglomerates - firm controls or produces in several different markets
        • General Electric (GE) owns (or majority shareholder) in NBC Universal, electricity generation, finance, medical equipment.
        • Problem is its focus is too wide spread
  • Accounts for 20% of business firms
  • Collects 84% of the business revenue

Similarities and Differences between Public and Private Sectors

Government - public sector and includes federal, state, and municipal governments

  • municipal government is city and county governments

1. Similarities:

  1. Economic efficiency - benefits of activity > costs
    • Cost-Benefit Analysis
    • Most value from resources
    • Society benefits
    • Examples:
      • Firm's profits > 0
      • Consumer's marginal utility > 0
    • If benefits < costs, then the activity is inefficient
      • Firm's profits < 0
      • Consumer's marginal utility < 0
    • Government should be efficient, but usually is not
  2. Competitive behavior is present
    • Agencies compete for tax dollars
    • Politicians compete for office
    • Firms compete for customers
  3. Scarcity imposes financial restrictions
    • Total government spending = total taxes collected
      • Government can borrow funds, but borrowing is restricted by future tax increases
    • Total business revenue > total costs
      • A business could earn losses, but only temporary losses
    • "No free lunch"

2. Differences:

  1. Government sets legal structure, while firms follow rules
    • "Rules of the game"
    • A process for settling disputes
      • Interact peacefully
    • Protect private property against invaders
  2. Government can use force to modify human behavior
    • Remove life (e.g. death penalty)
    • Remove liberty (e.g. prison & jails)
    • Seize property (e.g. taxes, fees, & fines)
  3. Government can redistribute wealth and income
    • Private market: A person who buys Coca-Cola drinks the Coca-Cola
      • A person's consumption is linked to his purchases
    • Public sector:
      • Transfer payments - transfer income from one group to another group
        • Welfare, food stamps, social security, Medicaid, Medicare, college financial aid, etc.
  4. Transactions in a private sector is voluntary, while government can use force like paying taxes
    • Tax Systems
      1. Progressive tax - Richer households are taxed more heavily than poor households
        • U.S. has a progressive income tax
      2. Proporational tax - everyone is charged the same percentage on income
        • Russia and Kazakhstan has a flat tax
      3. Regressive tax - poorer households are taxed more heavily than rich households
        • Social security, Medicare, property taxes, sales tax on food, and excise taxes.
  5. Government is political
    • Democrats versus Republicans
  6. Income and power are distributed differently
    • Private sector: People who supply highly valued goods / services tend to have high incomes. (1/2 the millionaires earned their fortunes from real estate).
    • Public sector: Campaigning, fund raising, and public relations help capture voters

The Opportunity Cost of Government

Sum the following:

  1. Government consumes goods, services, and resources
    • Major resource is labor
      • They could be working in private sector
    • Goods, services, and resources could be used by private sector
  2. Government consumes resources to collect taxes, and enforce government regulations and mandates
    • Cost to prosecute and punish violators
  3. Deadweight loss from taxes and regulations
    • They cause higher market prices and lower market quantities

Resasons for Government Intervention

Violates the invisible hand. Gives government valid reasons to regulate or control a market.

1. Lack of Competition: Sellers collude together to decrease production. They act like a monopoly.

  • Example: OPEC - reduce the production of oil (i.e. supply function shifts left)
    • Acts like a monopoly
    • Monopoly - one firm is the sole supplier/producer in a market
      • High market price
      • Low quantity produced
      • High profits
Petroleum Market
A supply decrease in a market

2. Externalities - failure to include all costs and benefits

  • Negative externality - an individual's or firm's action harms others without their consent
  • Property rights are not defined well
  • Not all costs are registered, therefore supply function understates the true cost of production
  • Example: A polluting firm
    • A firm supplies Q* which sell for P* and freely pollutes
    • Pollution is a social cost to society
    • Government can force the firm to include pollution costs, causing the supply function to shift left
      • Taxes, regulations, pollution permits, etc.
      • Equilibrium price increases while quantity supplied decreases
      • This is efficient because firm pays all costs including pollution
      • Firms still pollute, but less
A Polluting Firm
An externality in a market

 

  • Positive externality - an individual's actions generate benefits for nonparticipating parties
  • Demand functions understates the true value of output
  • From the viewpoint of efficiency, too few units may be produced
  • Example: Inoculations - people getting inoculated help prevent the spread of diseases.
    • People who are not inoculated also benefit
    • The market price and quantity is P*and Q*
    • Government can subsidize inoculations, bringing the market price down
Market for Innoculations
A supply increase in a market

3. Public Good - government produces good, because firms have difficulty supplying good through the market.

  • Two conditions:
  • (i) Every one can consume the good at the same time
    • Also called non-rival
  • (ii) Nonexcludable - the good cannot be restricted to the customers who pay for it
    • Payment is not linked to consumption of good
    • Free riders - person has no incentive to pay for public goods
      • Free riders will consume public good, but not help pay for it
  • Examples:
    • National defense (military)
    • Radio and television broadcast signals (FCC)
    • Clean air (EPA)
    • Stable monetary and financial environment
      • Federal Reserve System, i.e. central bank.
      • Influences inflation, interest, and foreign exchange rates
      • Controls/creates money supply
      • Regulates private banks, etc
  • Quasi-public goods - market could supply these goods, but the supply would not be enough
    • Postal service
    • Highways
    • Libraries
    • Education
    • Sewage disposal

4. Poor information

  • Asymmetric information - either the buyer or seller has more information than the other side
    • Examples:
      • A person buys fire insurance, knowing he faulty wiring in his home
      • Credit card companies - calculating interest rates
      • Difficult to inspect good or seldom purchases the good from the same producer
      • Some firms will provide:
        • low-quality
        • defective
        • even harmful goods
  • Asymmetric information problem is minimized by purchasing good regularly or through brand names, franchises, and product warranties.

Government Statistics

Circular Flow with Government

A circular flow with government

  • U.S. Government Receipts - from taxes and fees
    • Personal Income Taxes - federal taxes on income
      • Payroll taxes - income taxes are taken out of each paycheck
    • Corporate Income taxes - taxes levied on corporations
      • Double taxation
        • Corporations are taxed on profits
        • Investors are taxed on income as corporations pay dividends
          • Dividends - corporation pays some of its profits to shareholders per share
    • Social Security (FICA) taxes
      • Approximately 8%
      • A matching tax
        • Employee pay approx. 8%
        • Employer matches payment
      • Note - Medicare is a matching tax too!
    • Excise taxes - taxes that are levied on specific products
      • Excise taxes on alcohol, tobacco, and gasoline
      • Not shone because they are small taxes
    • Sales taxes are levied on a variety of goods
      • Usually a percentage on things sold in retail

U.S. federal government receiipts

  • Gross Domestic Product (GDP) - value of all goods & services produced in an economy in one year.
    • "Measure the size of a country"
    • We can see how taxes grow relative to the size of the economy

U.S. government receipts as percentage of GDP

  • Government Expenditures (or outlays)
    • National Defense - Military spending
    • Payments to people - includes transfer payments
    • Grants to State and Local Governments - federal government gives money to gov.
      • Not free money - many conditions apply
      • A way to get local governments to do what the federal government wants
    • Interest on U.S. Debt - government borrows money to cover shortfall
      • Net interest on the national debt
      • Government agencies hold approximately 40% of the debt

U.S. government expenditures

  • Government outlays relative to GDP

U.S. government expenditures as percent of GDP

  • U.S. government compared to other countries' governments
    • Europe - ranges from 40% to 60% in 2006
      • More socialism
    • Asian - ranges from 17% to 25% in 2006
      • Economic growth engines
  • State governments - rely on sales, excise, and income taxes
    • Education and public welfare are big expenses
  • Local governments- rely on property taxes
    • Property tax - government assesses a value on property and collects a percentage of that value every year
    • Majority goes to public education like schools
  • Note - seven states do not have an income tax
    • Taxes tend to be smaller, but these states over rely on property taxes and fees
      • Property taxes and fees tend to hit the poor more

My Notes:

  • Easy for government to grow in size but difficult to reduce
    • Called Parkinson's Law
  • Government tries to find new tax revenue sources
  • Bureaucrats have self-interest
    • Maintain their jobs and importance, not necessarily helping people
    • Expand programs
    • Design programs that are long term
    • Justify programs and importance to legislators, i.e. funding
Blue Arrow Gov can do great things, but can be oppressive and evil

Terminology

  • functional distribution of income
  • personal distribution of income
  • disposable income
  • durable goods
  • nondurable goods
  • services
  • plant
  • firm
  • industry
  • sole proprietorship
  • partnership
  • corporation
  • limited liabilitY
  • stock
  • bond
  • economic efficiency
  • monopoly
  • externalities
  • negative externalities
  • positive externalities
  • public goods
  • nonexcludable
  • free-riders
  • quasi-public goods
  • asymmetric information
  • government purchases
  • transfer payments
  • personal income tax
  • payroll taxes
  • corporate income tax
  • dividends
  • sales and excise taxes
  • property taxes
  • Gross Domestic Product (GDP)
 

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