The U.S. Economy Public and Private Sectors

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Chapter 4 Chapter 4 Objectives

• By end of chapter you should be able to – Define and explain the relative importance of five shares of functional distribution of income – Define and explain personal distribution of income – Understand the top and bottom 20% of distribution of income – State categories of household spending and income

Chapter 4 Objectives

• By end of chapter you should be able to – Explain advantages of corporations – Explain how government promotes business and competition – How government alters income distribution – Explain effects of positive and negative externalities – Explain role and methods government and central bank use to reduce unemployment and inflation Chapter 4 Objectives

• By end of chapter you should be able to – Differentiate between government purchases and transfer payments • And importance over time – ID Government sources of revenue and categories of spending – ID State and Local government sources of revenue and categories of spending

Chapter 4 Terms

• Functional distribution • Sole proprietorship of income • Partnership • Personal distribution • Corporation of income • Stock • Durable goods • Bond • Nondurable goods • Limited liability • Services • Principal – agent • Plant firm problem • Industry Chapter 4 Terms

• Monopoly • Average tax rate • Externality • Payroll taxes – Positive • Corporate income tax – Negative • Payroll taxes • Public goods • Sales and excise taxes • Government purchases • Property taxes • Transfer payments • Personal income tax • Marginal tax rates Elements to An Economy

• Consumers • Businesses • Government

• This chapter looks at all three in detail Remember The Wealth Of The U.S. Think • If you were an economist, do you see problems with the previous graph? – If yes, what are the problems? – If no, why are there no problems? • If you were an economist and you were creating a theory, is this type distribution good, bad or neutral for an economy? – Why? Please elaborate • What are your theories as to why there is so much of a difference in income

Remember The Wealth Of The U.S. Households as Income

• About 115 million households in U.S. • Household is one or more persons occupying a housing unit • Households and persons are – Ultimate suppliers of economic resources – And major spenders in the US economy Households as Income

• Income received by households is categorized – How it is divided and how it is earned Household Income

• How can you, or someone in your household make money? Households as Income

• Functional distribution of income – How a nations income is apportioned • Wages and salaries • Proprietors income • Rents • Interest • Corporate Profits – Or according to function performed by income receiver • These are payments for FACTORS OF PRODUCTION – Labor, land, capital, entrepreneurs

Households as Income

• Functional distribution of income – Wages • Paid to laborers or owners of businesses – Rents and Interest • Paid to owners of property resources – Real property, bonds, savings accounts – Profits • Paid to owners of corporations and unincorporated businesses – Stock or owners equity – This is where billionaires become billionaires

Please Answer

• What is your opinion about stocks and the stock market? – Where did the opinion come from? Households as Income

– Profits • Paid to owners of corporations and unincorporated businesses – Stock or owners equity – This is where billionaires become billionaires

Functional Distribution of Income Functional Distribution of Income Personal Distribution of Income

• How money is divided among individual households • Divided by quintiles, or five numerically equal parts • Quintiles are compared • Comparisons show vast unequal distribution of income Personal Distribution of Income

• How money is divided among individual households 2011

Compare

Personal Distribution of Income

• How income is divided among individual households • 12.6% of inc to 40% households 49% $ to top 20% 72% $ to top 40%

• Income in US • $13,401,868,693,000 • 72+% to top 40% • $9,649,345,458,960 to top 40%

– About $214,429 per household annually • 3,752,523,234,040 – Average about $50,000 per household

Answer

• In economic terms, what are most of the families in this area? – Upper – Middle – Lower class

– Please explain your answer and why you answered the way you did • What would the United States be like if we had a significantly smaller middle class? Household Income

Real World Moment

• Federal reserve had been pumping $85 billion into US economy each month – 72% to top 40% wage earners • Where do they put their money?

• With the “tapering” of the stimulus money by the Feds, what would you expect to happen? Conclusion

• If the government cuts off the $85 billion in stimulus to the economy each month, what will happen? – Simple supply and demand in the stock market PA Distribution Of Income Households as Spenders

• Disposal of income – Taxes about 12% • 46% pay no tax and often get a refund – Savings: • Varies by income level – National average close to 0% in 2000 - 2001 » Home equity borrowing – National average about 3.3% 2009 – 2012 – Most income goes to consumer spending – Saving and spending varies with income levels Savings Rate In The US Households as Spenders

• As of 2005 Consumer Spending

• Most income goes to consumer spending • Several categories – Durable goods – Non durable goods – Services • More than half of consumer spending

Goods & Services

• Durable goods – Life expectancy of 3 years or more • Nondurable goods – Food and clothing • Services – Insurance, medical, education, legal Categories of Spending If You Had $1,000 • What would you do with it? 1. Make a list of what you would do with the money 2. Is it a durable good, non durable good or service? 3. Break it down into percentages of type of good 4. In your rows--- 1. How much did your row have to “spend?” 2. % in non durable goods, durable goods and services 3. Did anyone “save money”? 4. As a class, how do you compare to the overall spending of the average consumer? 5. What factors contribute to the differences vs the “average consumer?”

• Discussed yesterday the importance of durable good spending on an economy • Explain why durable good spending, and durable goods reports are so important to an economy. • Go to my web site – Microeconomics – Ch 4 – durable goods and their importance – Answer: 1. Why is this report, the durable goods report, so important? 2. What has it “predicted” over the last 12 years? 3. Based on the current statistics, what do you theorize will happen to the economy in the short term? Please explain Categories of Spending – All

Business Population

• Second component of private sector – Households is the first • Business is broken down by Legal forms and Size

• Explain why businesses are important to an economy – Produce products purchased by consumers – Employ the consumers • Small businesses employ 57.2% of the non farm workforce • With employment comes pay – Create new jobs • Small business creates 81% of all new jobs – Provide innovation to the economy – Export goods overseas providing goods overseas and more domestic jobs – Pay taxes Business

ENTERPRISE NUMBER OF AREA DESCRIPTION EMPLOYMENT SIZE NUMBER OF FIRMS ESTABLISHMENTS EMPLOYMENT

United States 1: Total 5,734,538 7,396,628 111,970,095

United States 2: 0-4 3,575,240 3,582,826 5,926,452

United States 3: 5-9 968,075 982,019 6,358,931

United States 4: 10-19 617,089 652,662 8,288,385

United States 5: <20 5,160,404 5,217,507 20,573,768

United States 6: 20-99 475,125 648,386 18,554,372 7: 100- United States 499 81,773 354,313 15,868,540

United States 8: <500 5,717,302 6,220,206 54,996,680

United States 9: 500+ 17,236 1,176,422 56,973,415 http://www.census.gov/econ/susb/ PA Businesses

ENTERPRISE EMPLOYMENT NUMBER OF AREA DESCRIPTION SIZE NUMBER OF FIRMS ESTABLISHMENTS EMPLOYMENT

Pennsylvania 1: Total 231,192 297,023 4,976,193

Pennsylvania 2: 0-4 131,847 132,066 231,401

Pennsylvania 3: 5-9 41,063 41,561 269,441

Pennsylvania 4: 10-19 26,933 28,281 360,841

Pennsylvania 5: <20 199,843 201,908 861,683

Pennsylvania 6: 20-99 22,119 28,437 827,944

Pennsylvania 7: 100-499 5,292 15,897 729,406

Pennsylvania 8: <500 227,254 246,242 2,419,033

Pennsylvania 9: 500+ 3,938 50,781 2,557,160 http://www.census.gov/econ/susb/ Classifications & Definitions

• Four legal forms of businesses – Sole Proprietorship – Partnership – Corporation – LLC is Limited Liability Company - May not shelter owner from liability - Most prevalent form of business in US • Run a full range from “mom & pop shop” to Exxon Mobile and Wal-Mart • What companies are the largest in the world? 10 Largest US Companies

10. Ford 5. Berkshire Hathaway 9. Valero Energy 4. Phillips 66 8. General Electric 3. Chevron 7. General Motors 2. Exxon Mobil 6. Apple 1. Wal-Mart

BERKSHIRE HATHAWAY INC.

Acme Brick Company IMC International Metalworking Companies Applied Underwriters Johns Manville Ben Bridge Jeweler Jordan's Furniture Benjamin Moore & Co. Justin Brands Berkshire Hathaway Homestate Companies Larson-Juhl BoatU.S. Lubrizol Corporation Borsheims Fine Jewelry Marmon Holdings, Inc. Brooks McLane Company Buffalo NEWS, Buffalo NY Medical Protective BNSF MidAmerican Energy Holdings Company Business Wire MiTek Inc.

Central States Indemnity Company National Indemnity Company

Clayton Homes Nebraska Furniture Mart CORT Business Services NetJets® CTB Inc. Omaha World-Herald Fechheimer Brothers Company Oriental Trading Company FlightSafety The Pampered Chef® Forest River Precision Steel Warehouse, Inc. Fruit of the Loom Companies RC Willey Home Furnishings Garan Incorporated Richline Group Gateway Underwriters Agency Scott Fetzer Companies GEICO Auto Insurance See's Candies General Re Shaw Industries Guard Insurance Group Star Furniture Helzberg Diamonds TTI, Inc. H.H. Brown Shoe Group United States Liability Insurance Group HomeServices of America, a subsidiary of XTRA Corporation MidAmerican Energy Holdings Company International Dairy Queen, Inc. Business in the U.S.

20% Corporations

8% Partnerships

72% Sole Proprieterships Sales in the U. S.

11% 5% Corporations Sole Proprietership Partnerships 84% Advantages Of Corporations

• Most efficient at raising money • Most options for raising money – Stocks – Bonds – Traditional borrowing

• Limited Liability • Investors are able to spread risk Classifications & Definitions

• A Plant – Physical place • factory, farm, mine, store, warehouse • Fabrication or distribution of goods or services • A Firm – Business organization that owns plants • An industry – A group of firms that produce similar or same products

Business Population/Type

• An industry – A group of firms that produce similar or same products • Examples include the automobile industry or the tobacco industry. – Confusion often occurs because many businesses are multiproduct firms. Business Population/Type

• Types of multiplant firms: – Horizontal integrated: • a multiplant firm with plants in the same stage, like a retail chain store such as Wal-Mart or Safeway. – 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. • c. Conglomerate: a firm that owns plants in different industries or markets. – Berkshire Hathaway • Geico • Coca Cola Principal-Agent Problem

• In not a “Market Failure” in economic terms – Really a function of rational self interest • Principals are stockholders • Agents run the businesses as agents of stockholders • The problem: Interests of agents may not be the same as the principles • Big reason for government rules/laws • Consider This … Unprincipled Agents • Executive stock options in 1990s were thought to correct principal-agent problem that led to fraud and abuse, as in the Enron and WorldCom cases. Deceptive (and in some cases illegal) accounting practices were used to inflate company stock prices so that executives could sell their shares and reap huge windfalls. Look It Up

• What happened to Enron? Review

• Page 70, 4.2 quick review • Problems 4 & 5 page 82 • Economists define saving as: • A) that part of after-tax income which is not consumed. • B) total income less taxes. • C) bank accounts. • D) purchases of stocks and bonds. • Households in the aggregate use the largest share of their total income to: • A) pay taxes. • B) consume. • C) save. • D) buy capital goods. • Economists define durable goods as those products expected to last at least _____ year(s). • A) 1 • B) 3 • C) 5 • D) 10 • In economics, a group of firms that produce identical or similar products is called a(n): • A) industry. • B) plant. • C) conglomerate. • D) firm. Principal-Agent Problem

• In not a “Market Failure” in economic terms – Really a function of rational self interest • Principals are stockholders • Agents run the businesses as agents of stockholders • The problem: Interests of agents may not be the same as the principles • Big reason for government rules/laws Write • You are the CEO of a Big corporation. You have a choice: You can make the stock price go up by 30% now ($100 to $130) and receive a $10,000,000 bonus for your results. However, you know in the long run it will hurt the company and stock owners (shareholders). • WHAT WOULD YOU DO AND WHY? • 5 paragraph essay • 12 points

• 12 points • 3 reasons with explanations as to WHY you made the decision you made • Your act is not illegal and will not get you in trouble with the government • The bonus structure is simply part of your employment package • Use a 5 paragraph essay format – See my writing tips page if you do not know structure Market Failures and the Role of the Government

87 You want light?

Pay me!!! Answer • Why are street lights paid for by government? – Business can not make money from a street light – People want them for various reasons • Safety • Visibility – Have shared consumption or joint use – “Why should I pay for the street light if everyone else gets the benefit. It is a public good and is provided by the government when not provided by the private sector

Four Market Failures

• 1. Public Goods • 2. Monopolies • 3. Distribution of Income • 4. Externalities

• ACDC Market failure video

Market Failure #1 Public Goods

91 • Public Goods / Public Sector The part of the economy concerned with providing basic government services. The composition of the public sector varies by country, but in most countries the public sector includes such services as the police, military, public roads, public transit, primary education and healthcare for the poor

• What is a market failure?

• Example of Market failure • If that is the case, why is the government imposing healthcare on the US when the private sector provides – 46 million American not covered – 15.7% of population and rising • Rising healthcare cost main reason • Some states as high as 27% • #1 reason for bankruptcy • Hits low income earners hardest • Govt. pays for ER visits of this demographic Four Market Failures

• 1. Public Goods • 2. Monopolies • 3. Distribution of Income • 4. Externalities

Public Sector Governments Role • Provides a legal structure – Property rights – Enforcement of contracts – Sets “rules of the game” • By controlling relationships between businesses, suppliers, consumers – Acts as referee • Imposes penalties for fouls Government Intervention • Look It Up • Economically speaking, when does the government intervene? Think immediate/emergency intervention – High unemployment rates – Sale of stocks – Inflation is high – Immediate health risk – Disasters – Money supply

Public Goods - Public Sector Governments Role • Market Interventions make – The market “safe” – Opportunity to widen/broaden the markets – Fosters specialization in use of property and human capital

Public Sector Governments Role • Key is balance – The Goldilocks Effect – Not too much or too little regulation or intervention – Strive for marginal benefit = marginal cost – OR – MB = MC (you will need to know this formula)

Governments Role

• Competition – A regulatory mechanism – Buyers are the boss in a market economy – Government has no competition so no “regulatory” mechanism • Exceptions to market competition – Monopoly • Single seller controls industry • Government monitors and regulates heavily Governments Role

• Monopoly – Single seller controls industry – Can charge higher prices by controlling supply – Government attempts to control through • Regulation • Antitrust – Sherman anti trust act

– Research the 2000 ruling against Microsoft

Government Role

• Redistribution of income – Market system is impersonal – Distributes income more inequitably than society desires • Generally yields large income to those who labor by virtue of – Inherent ability – Acquired education and skills – Have or possess land, capital

• Refer to the above competitive market diagram for product Z. Assume

that the current market demand and supply curves for Z are D2 and S2. If there are substantial external costs associated with the production of Z, then: A. a price lower than B and an output greater than G would improve resource allocation. B. government should levy a per unit excise tax on Z to shift the demand curve to the right. C. government should levy a per unit excise tax on Z to shift the supply

curve toward S1. D. government should subsidize the production of Z to lower equilibrium price and increase equilibrium output.

• C. government should levy a per unit excise tax on Z to shift the supply

curve toward S1.