Lecture Economics (18th edition): Chapter 4 - McConnell, Brue, Flynn''s

Chapter 4 - The U.S. economy: Private and public sectors. The chapter answers some very important questions: What types of income do households receive and how do they dispose of it? What are the types of business enterprises and why has the corporate form of business dominated? What is government’s economic role in the economy and how does it fit into the circular flow diagram? What are the sources of government revenues and how does it allocate its expenditures?

The U.S Economy: Private and Public Sectors

Chapter 4

• Principle agent problem

• The economic role of

government

• Government spending and

sources of revenue

4-2

Household Income

–Types of income

–Wage, rent, interest, profit

• Personal distribution of income

–Division among households by

quintile

Personal Distribution of Income

2006

Lowest 20%

Second 20%

Middle 20%

Fourth 20%

The Business Population

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?

Government’s Role

• Provide the legal structure

–Set the laws we live by

Correcting for Externalities

The Circular Flow Revisited

Resource Market

Product

Goods &

Services Services Goods &

Net Taxes Net Taxes Expenditures

Expenditures Goods &

Services Resources

Government Finance

• Government purchases

• Government transfers

35 30 25 20 15 10 5 0

Government Transfer Payments

Government Revenue

Sweden Denmark Finland France Italy Germany United Kingdom

Canada Australia United States

58 55 51 51 46 43 42 40 35 34

Total Tax Revenue, Approximate Percentage

of GDP, 2007

Interest on the Public Debt

Federal Tax Revenues

Personal Income Tax

Payroll Taxes

Corporate Income Taxes

Excise Taxes

45% 34%

3%

14%

Sources of total tax revenue ($2,568 billion), 2007

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%)

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

Key Terms

• functional distribution of income

• personal distribution of income

• personal income tax

• marginal tax rate

• average tax rate

• payroll taxes

• corporate income tax

• sales and excise taxes

• property taxes 4-28

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The United States

in the Global

Economy