EC 111 Lecture Notes - Lecture 5: Deflation, Socalled, Tax Rate
4 Jun 2018
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Chapter 5: The U.S. Economy ā Private and Public Sectors
Goals of Chapter
ā¢ To acquire basic factual information about the household and business components of the private sector
economy.
ā¢ To acquire basic factual information about the public (or government) sector in the U.S. economy.
ā¢ To understand the role of the public sector in the U.S. economy.
Households as Income Receivers
ā¢ Functional distribution of income is shown in Figure 5-1.(This figure is based on NI-National Income.)
ā¢ Wages and salaries are 70 percent of total.
ā¢ Proprietors' income (income to self-employed business owners, doctors, lawyers, etc.) is under 10 percent of
total.(This is a combination of wage and profit income.)
ā¢ Capitalist income-corporation profits, rent, interest-is less than one-fifth of total.(Note: rent may be negative
because of the depreciation charged against rental income.)
ā¢ Personal distribution of income is shown in Figure 5-2.(This figure is based on PI-Personal Income.)
ā¢ It is often described by dividing the population into quintiles or five numerically equal parts.
ā¢ Proportions of total income going to each quintile are then compared.
ā¢ Comparison shows unequal distribution of income.For example, see how many times greater the share of
income going to the top quintile is relative to the bottom fifth.(Key Question 2)
Households As Spenders (Figure 5-3) (Figure is based on PI-Personal Income)
ā¢ Use Figure 5.3 or most recent data from Survey of Current Business, January issue of current year, to describe
the following.
ā¢ How do households dispose of their income?
ā¢ Personal taxes, of which Federal personal income tax is the major component, has increased over the years.
ā¢ Saving (dissaving if spending exceeds income) is the smallest fraction of personal income disposition.
ā¢ Most of household income goes to consumer spending (Figure 5.3).There are several categories of spending
categories (Figure 5.4):
ā¢ Durable goods are those with life of three or more years.
ā¢ Nondurable goods include things such as food and clothing.
ā¢ Services are today more than one-half of all consumer spending, which demonstrates that ours is a service-
oriented economy.
The Business Population
ā¢ Related definitions:
ā¢ Plant:physical establishment where production or distribution takes place (factory, farm, store).
ā¢ Firm:business organization that owns and operates the plants.(The legal entity.)
ā¢ Industry: a group of related firms, producing the same or similar products.
ā¢ Examples include the automobile industry or the tobacco industry.
ā¢ Confusion often occurs because many businesses are multiproduct firms.
ā¢ Types of multiplant firms:
ā¢ Horizontal integrated: a multiplant firm with plants in the same stage, like a retail chain store such as J. C.
Penney or Safeway.
ā¢ Vertical integrated: a multiplant firm in which the company owns plants at different production stages.
Example: A steel company may own ore and coal mines as well as different plants in different stages of the
manufacturing process.
ā¢ Conglomerate: a firm that owns plants in different industries or markets.
ā¢ Legal forms of businesses(Figure 5.5):
ā¢ Definition:
ā¢ Sole proprietorship: a business owned by a single individual.
ā¢ Partnership: two or more individuals own and operate the business in a partnership agreement.
ā¢ Corporation: a legal entity distinct from its individual owners. The organization acts as "legal person."
ā¢ Discussion of Figure 5-5 relative to most important - percentage of firms versus percentage of sales.
ā¢ Sole proprietorship
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ā¢ Advantages: easy to set up; proprietor is his/her own boss; because profit is proprietor's income, there is an
incentive to operate the business efficiently.
ā¢ Disadvantages: financial resources are limited and insufficient; the proprietor is responsible for all of
management functions; the proprietor is subject to unlimited liability.
ā¢ Partnership
ā¢ Advantages: easy to organize; greater specialization; better access to financial resources than
proprietorships.
ā¢ Disadvantages: some of the same shortcomings of the proprietorship; possible difficulties in sharing
management responsibilities; still limited financial resources; problems if one of the partners leaves; still
unlimited liabilities.
ā¢ Corporations
ā¢ Advantages: improved ability to raise financial capital (money); defining and comparing stocks and bonds;
limited liabilities; corporations have a permanence that is conducive to long-run planning and growth.
ā¢ Disadvantages: red tape and expense in obtaining a corporate charter; unscrupulous business owners
sometimes avoid responsibility for questionable business activities.
ā¢ Hybrid structures
ā¢ Principle-agent problem
The Public Sector: Government's Role
ā¢ Providing the legal structure:
ā¢ Government ensures property rights, provides enforcement of contracts, acts as a referee and imposes
penalties for foul play.
ā¢ Government intervention improves the allocation of resources by supplying a medium of exchange, ensuring
product quality, defining ownership rights, and enforcing contracts.
ā¢ These interventions widen the market and foster greater specialization in the use of property and human
resources.
ā¢ The appropriate amount of regulation is at the level where the marginal benefit and marginal cost are equal.
ā¢ Maintain competition:
ā¢ Competition is the market mechanism that encourages producers and resource suppliers to respond to
consumer sovereignty.
ā¢ If producers (and/or resource suppliers) have monopoly power, the monopolist can charge higher-than-
competitive prices and supplant consumer sovereignty with producer sovereignty (or economic rent).
ā¢ If "natural monopoly" exists, government regulates price and service.(Natural monopoly exists when
technology or economic realities make a monopoly more efficient than competition.)
ā¢ Where competitive markets are more efficient, anti-monopoly laws (Sherman Act of 1890; Clayton Act of
1913) are designed to regulate business behavior and promote competition.
ā¢ Redistribution of income:
ā¢ Transfer payments provide relief to the poor, dependent, handicapped, and unemployment compensation to
those unemployed who qualify for benefits.Social Security and Medicare programs support the sick and aged.
ā¢ Government intervenes in markets by modifying prices.Price support programs for farmers; minimum wage
laws are examples.
ā¢ Taxation takes a larger proportion of incomes of the rich than the poor.
ā¢ Reallocation of resources:
ā¢ Market failure occurs when the competitive market system produces the "wrong" amounts of certain goods
or services or fails to provide any at all.
ā¢ Spillovers and externalities
ā¢ Spillovers or externalities occur when some of the benefits or costs of production are not fully reflected in
market demand or supply schedules. Some of the benefits or costs of a good may "spill over" to third parties.
ā¢ An example of a spillover cost is pollution, which allows polluters to enjoy lower production costs because the
firm is passing along the cost of pollution damage or cleanup to society. Because the firm does not bear the
entire cost, it will overallocate resources.
ā¢ Correcting for spillover costs requires that government get producers to internalize these costs.
ā¢ Legislation can limit or prohibit pollution, which means the producer must bear costs of antipollution effort.
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