Chapter 3 ECON4 William A.

McEachern

Economic
Decision
Makers

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 The Household
• Demand goods and services
– What gets produced
• Supply resources
– Produce output
• Choices
– What to buy
– How much to save
– Where to live
– Where to work
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 The Evolution of the Household
• Farm household
– Self-sufficient
• Better technology
– Increased productivity
• Factories
– Specialization; less self-sufficient
• Women in labor force
– 1950: 15%
– Today: 70%
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 The Household
• Maximize utility
– Satisfaction received from consumption
– Sense of well-being
– Depends on each household’s subjective
goals

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 The Household
• Resource suppliers
– Labor, capital, natural resources, and
entrepreneurial ability
– To satisfy their unlimited wants
– Labor – to earn income
• Households with few resources
– Transfer payments - outright grants
• Cash transfers
• In-kind transfers
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 The Household
• Demanders of goods and services
– Durable goods
• Expected to last 3 or more years
– Nondurable goods
• Food, clothing, gasoline
– Services

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Exhibit 1
Where U.S. Personal Income Comes From and Where It Goes

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 The Evolution of the Firm
• Specialization
• Comparative advantage
• Transaction costs
• Entrepreneur
• Cottage industry system
• Technological developments

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 The Evolution of Firm
• Large – scale factory production
– Efficient division of labor
– Direct supervision of production
– Reduce transportation costs
– Bigger machines
• Industrial Revolution
• Large-scale factory production
• Began in Great Britain around 1750
• Spread to: Europe, North America, Australia
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 The Firm
• Firms
– Economic units
– Profit seeking entrepreneurs
– Combine resources
– Produce goods and services
– Maximize profit

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 Types of Firms
• Sole proprietorship
– Single owner
• Has the right to all profits
• Bears unlimited liability for the firm’s losses
and debts
• Partnership
– Two or more owners
• Share the profits
• Bear unlimited liability for the firm’s losses
and debts
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 Types of Firms
• Corporation
– Legal entity owned by stockholders
– Whose liability is limited to the value of
their stock ownership
• S corporation
– Provides owners with limited liability
– Profits are taxed only once
• A income on each shareholder’s personal
income tax return
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Exhibit 2
Percent distribution by type of firm based on number of
firms and firm sales

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 Types of Firms
• Cooperatives
– People who pool their resources to buy
and sell more efficiently than they could
individually
• Consumer cooperatives
– Retail business owned and operated by
some or all of its customers
– To reduce costs

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 Types of Firms
• Producer cooperatives
– Producers join forces to buy supplies and
equipment and to market their output
– To reduce costs and increase profits
• Not-for-profit organizations
– Do not pursue profit as a goal
• Charitable; Educational
• Humanitarian; Cultural
• Professional
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 Household Production
• Opportunity cost
– Below market price
• No skills or special resources are
required
• Avoid taxes
• Reduce transaction costs
• Technological advances increase
productivity

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 Household Production
• Information revolution
– Technological change spawned by the
microchip and the Internet
– Enhanced the acquisition, analysis, and
transmission of information

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 The Government
• Role of government
– To intervene in case of market failure
• Market failure
– Arises when the unregulated operation of
markets
– Yields socially undesirable results

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 The Role of Government
• Establish & enforce rules of the game
– Safeguard private property
– Make sure that market participants abide
by the rules of the game
• Promote competition
– Antitrust laws that prohibit
• Collusion (agreement among firms to divide
the market and fix the price)
• Unfair business practices

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 The Role of Government
• Regulate natural monopolies
– Monopoly
• Sole supplier of a product with no close
substitutes
– Natural monopoly
• One firm that can supply the entire market at
a lower per-unit cost than could two or more
firms

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 The Role of Government
• Provide public goods
– Funded with taxes
– Private firms cannot sell them profitably
• Private goods
– Rival in consumption
– Exclusive
• Public goods
– Nonrival in consumption
– Nonexclusive
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 The Role of Government
• Deal with externalities
– Use taxes, subsidies, and regulations
• To discourage negative externalities
• To encourage positive externalities
• Externality
– Cost or benefit that affects neither the
buyer nor seller
– Affects people not involved in the market
transaction
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 The Role of Government
• More equal distribution of income
– Transfer payments
• Fostering a healthy economy
– Full employment
– Price stability
– Economic growth

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 The Role of Government
• Fiscal policy
– Use of government purchases, transfer
payments, taxes, and borrowing
– To influence economy-wide variables
• Monetary policy
– Regulation of the money supply
– To influence economy-wide variables

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 Government’s Structure & Objectives
• National/federal government
– National security, economic stability,
market competition
• State government
– Public higher education, prisons,
highways, welfare
• Local government
– Primary and secondary education, police,
fire protection
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 Government’s Structure & Objectives
• Difficulty
– More than 89,500 jurisdictions
• 1 nation
• 50 states
• 3,033 counties
• 35,991 cities and towns
• 13,051 school districts
• 37,381 special districts
– Not one single decision maker
• ‘Vote maximization’
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 Government’s Structure & Objectives
• Voluntary exchange vs. coercion
– Some government coercion
– Enforced by the police
• No market prices
– Public output
• Zero price
• Below the production cost

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 Size and Growth of Government
• Government outlays relative to GDP
– 1929: 10% of GDP
• Mostly state and local
– 2013: 40% of GDP
• Mostly federal
– Defense
• Decreased
– Redistribution
• Increased
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Exhibit 3
Redistribution Has Grown and Defense Has Declined as
Share of Federal Outlays Since 1960

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 Sources of Government Revenue
• Taxes
– Individual income tax (federal)
– Income tax; sales tax (state)
– Property tax (local)
• User charges
• Borrowing
• Monopolize certain markets

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Exhibit 4
Payroll Taxes Have Grown as a Share of Federal Revenue
Since 1960

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 Tax Principles and Tax Incidence
• Ability-to-pay tax principle
– Those with a greater ability to pay
• Earning higher incomes
• Owning more property
– Should pay more taxes
• Benefits-received tax principle
– Those who get more benefits from the
government program should pay more
taxes
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 Tax Principles and Tax Incidence
• Tax incidence – who bears the burden of
the tax
– Proportional taxation
– Progressive taxation
– Regressive taxation

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 Tax Principles and Tax Incidence
• Proportional taxation
– Flat tax
– Tax as a percentage of income remains
constant as income increases
• Marginal tax rate
– Percentage of each additional dollar of
income that goes to the tax

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 Tax Principles and Tax Incidence
• Progressive taxation
– Tax as a percentage of income increases
as income increases
• Regressive taxation
– Tax as a percentage of income
decreases as income increases

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Exhibit 5
Top Marginal Rate on Federal Personal Income Tax Since 1913

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 The Rest of the World
• Rest of the world
– Foreign households, firms, governments
• International trade
– Occurs because of different opportunity
costs
• Merchandise trade balance
– Value of a country’s exported goods
minus the value of its imported goods
– During a given period
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 The Rest of the World
• Balance of payments
– Record of all economic transactions
– Between residents of one country and
residents of the rest of the world
– During a given period
• Foreign exchange
– Foreign money needed to carry out
international transactions

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 The Rest of the World
• Exchange rates
– Price of one currency in terms of another
– Foreign exchange markets
• Trade restrictions
– Tariff
• Tax on imports
– Quota
• Legal limit on the quantity of a particular
product that can be imported or exported

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 The Rest of the World
• Trade restrictions
– Benefit certain domestic producers
– Higher prices
– Hurt domestic consumers
– Interfere with the free flow of products
across borders
– Hurt the overall economy

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