ECN 112 Chapter 2 Lecture Notes

2.1 What Goods and Services are Produced? A. What We Consume 1. In the United States, medical care is the single largest consumption category. 2. Over time, incomes in the United States have increased and our expenditure on necessities has fallen as a percentage of income while expenditure on services has risen as a percentage of income. B. What We Produce Most of what we consume is produced in the United States, and most of what we produce is services. 1. As a percent of total production, real estate services represents the largest item produced. C. What We Buy From the Rest of World We sell goods to other countries and also buy goods, such as oil, produced in other countries. 2.2 How Are Goods and Services Produced? We use productive resources to produce the goods and services we buy. Economists call the productive resources factors of production, and group them into four categories. A. Land Land includes all the gifts of nature, or natural resources that we use to produce goods and services. Land includes land (in the everyday sense), minerals, energy, water, air, animals and plants. B. Labor Labor is the work time and work effort people devote to producing goods and services. 1. As the population increases or if a larger percentage of the population works, labor increases. 2. Human capital is the knowledge and skill that people obtain from education, on-the-job-training and work experience. 3. As human capital increases, the quality of labor increases. C. Capital Capital consists of the tools, instruments, machines, buildings, and other constructions that have been produced in the past and that businesses use to produce goods and services. It does not include financial capital like money, stocks, or bonds. D. Entrepreneurship Entrepreneurship is the human resource that organizes labor, land, and capital. 2.3 For Whom Are Goods Produced? A. Incomes determine who gets the goods and services produced. People earn incomes by selling the services of their factors of production. 1. Rent is paid for the use of land. 2. Wages are paid for the services of labor. 3. Interest is paid for the use of capital. 4. Profit (or loss) is income earned by an entrepreneur from running a business.

B. The functional distribution of income is the percentage distribution of income among the factors of production and shows that labor received 72 percent of total income in the United States in 2002. C. The personal distribution of income is the percentage distribution of income among households. It shows that the richest 20 percent of household received 47 percent of total income in the United States in 2001 and the poorest 20 percent received 5 percent of total income. 2.4 Circular Flows The circular flow model is a model of the economy that shows the circular flow of expenditures and incomes that result from decision makers choices and the way these choices interact to determine what, how, and for whom goods and services are produced. A. Households and Firms 1. Households are the individuals or groups of people who living together. Households own the factors of production, land, labor, capital, and entrepreneurship. 2. Firms are the institutions that organize the production of goods and services. B. Markets A market is any arrangement that brings buyers and sellers together and enables them to get information and do business with each other. 1. Goods markets are markets in which goods and services are bought and sold. 2. Factor markets are markets in which factors of production are bought and sold. C. Real Flows and Money Flows The real flows are the goods and services and the factors of production. The money flows go in the opposite direction to the real flows. D. Governments 1. Federal Government a. The federal government has three major expenditures: provide goods and services, make social security and welfare payments, and make transfers to state and local governments. b. The federal government collects three main taxes: personal income taxes, corporate (business) income taxes, and social security taxes. 2. State and Local Government a. The state and local governments have two major expenditures: provide goods and services and pay welfare benefits. b. The state and local governments collect three main taxes: sales taxes, property taxes, and state income taxes. E. Governments in the Circular Flow The government sector provides goods and services to both households and firms. Households and firms pay taxes to, and receive transfers from, governments. F. Federal Government Expenditures and Revenues 1. The largest expenditure categories are social security (23 percent of expenditures), other transfers (20 percent), national defense (18 percent), interest on the national debt (15 percent), and transfers to state and local governments (13 percent). 2. The largest sources of revenue are personal income taxes (48 percent of revenue), social security taxes (35 percent), and corporate income taxes (12 percent).

G. State and Local Government Expenditures and Revenue 1. The three largest expenditure categories are education (40 percent of expenditures), public welfare (20 percent), and highways (8 percent). 2. The largest sources of revenue are sales taxes (25 percent of revenue), transfers from federal government (23 percent), property taxes (21 percent), and individual income taxes (15 percent).