Chapter 4

The U.S. Economy: Private and Public Sectors

McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives
U.S. household and business facts The corporate form of business organization Principle agent problem The economic role of government Government spending and sources of revenue
4-2

Household Income
Functional distribution of income
Types of income Wage, rent, interest, profit

Personal distribution of income

Division among households by quintile

4-3

Functional Distribution of Income 2007

0 Income By Function Performed
Wages & Salaries

National Income Received (Percent) 10 20 30 40 50 60

70

71%
1% 5%

Rents

Interest

Proprietors Income

9%
14%
Source: Bureau of Economic Analysis 4-4

Corporate Profits

Personal Distribution of Income 2006

0 Income Group (Households) Lowest 20% Second 20% Middle 20% Personal Income Received (Percent) 10 20 30 40 50 60

3.4%
8.6% 14.5% 22.9% 50.5%
Source: Bureau of the Census 4-5

Fourth 20%
Highest 20%

Households as Spenders
Uses of household income? Personal taxes (13%) Personal saving (1%) Personal consumption (86%)
Durables (11%) Nondurables (29%) Services (60%)
4-6

The Business Population

Plant Firm Industry Multiplant firms Vertically integrated Conglomerates
4-7

Domestic Output
Sole proprietorship
Partnership Corporation
20% 8%
Corporations
Partnerships Corporations

84%

72% Sole Proprietorships

Partnerships Sole Proprietorships

11% 5%

Percentage of Firms

Percentage of Sales
Source: U. S. Census Bureau 4-8

Advantages of Corporations
Methods of finance
Stocks Bonds

Limited liability Hiring of specialists Unlimited lifetime

4-9

Principal-Agent Problem
Potential disadvantage of corporations Stockholders are principals

Executives are agents

Conflict of interest?

4-10

The Public Sector

Federal, state, and local government Role of the government in the economy?

4-11

Governments Role
Provide the legal structure
Set the laws we live by

Maintain competition
Monopoly and antitrust laws

Redistribute income
Transfer payments Market intervention Taxation
4-12

Governments Role
Reallocating resources
Market failure Negative externality Positive externality Public goods

4-13

Correcting for Externalities

Negative externalities
Legislation Specific taxes

Positive externalities
Subsidies Government provision of goods
4-14

Types of Goods
Private goods
Rival and excludable

Public goods
Nonrival Nonexcludable

Free-rider problem Quasi-public goods The reallocation process

4-15

Governments Role
Promoting stability
Unemployment Inflation

A qualification
Politics Too much or too little regulation Inefficiency
4-16

The Circular Flow Revisited

Resource Market
Expenditures Goods & Services Resources Goods & Services

Businesses
Net Taxes

Government
Net Taxes Goods & Services

Households

Expenditures

Product Market

4-17

Government Finance
Government purchases Government transfers
35

Percentage of U.S. Output

30

27%
25 20 15 10 5 0

Government Transfer Payments

32% 13%

5%

22% Government Purchases

1960

19%

2007
4-18

Government Revenue
Total Tax Revenue, Approximate Percentage of GDP, 2007 10 20 30 40 50
Sweden Denmark Finland France Italy Germany United Kingdom Canada Australia United States Japan South Korea 58 55 51 51 46 43 42 40 35 34 33 32
Source: Organization for Economic Cooperation and Development 4-19

Federal Expenditures
Percentage of total expenditure ($2,731 billion), 2007
0 10 20 30 40 50

Pensions & Income Security National Defense

34%

21%
24% 9%
Source: U. S. Office of Management and Budget 4-20

Health Interest on the Public Debt

Federal Tax Revenues

Sources of total tax revenue ($2,568 billion), 2007
0 10 20 30 40 50

Personal Income Tax Payroll Taxes Corporate Income Taxes Excise Taxes All Other

45% 34% 14% 3% 4%

Source: U. S. Office of Management and Budget 4-21

Personal Income Tax

Progressive tax rates
Brackets of income

Marginal tax rate Average tax rate

4-22

State Finances
Primary Revenues
Sales & Excise Taxes (47%) Personal Income Taxes (35%) Corporate Income Taxes & License Fees (18%)

4-23

State Finances
Primary Expenditures
Education (36%) Public Welfare (28%) Health & Hospitals (7%) Highways (7%) Public Safety (4%) Other (18%)
4-24

Local Finances
Primary Revenues
Property Taxes Sales & Excise Taxes 73% 17%

Primary Expenditures
Education 44% Welfare, Health & Hospitals 12% Public Safety 11% Housing, Parks, & Sewers 8% Streets & Highways 5%

4-25

Financing Social Security

Demographic changes Long-run shortfall in funding Pay-as-you-go plan Trust fund withdrawals Trust fund exhausted in 2041 Benefit reductions? Tax revenue increases?
4-26

Financing Social Security

Possible solutions
Stock & bond investments Payroll tax increases Individually directed accounts Privately owned and managed accounts

Consensus difficult
4-27

Key Terms
functional distribution of income personal distribution of income durable goods nondurable goods services plant firm industry sole proprietorship partnership corporation stock bond limited liability principal-agent problem

monopoly externality negative externalities positive externalities public goods free-rider problem quasi-public goods government purchases transfer payments personal income tax marginal tax rate average tax rate payroll taxes corporate income tax sales and excise taxes property taxes 4-28

Next Chapter Preview

The United States in the Global Economy

4-29