• Functional Distribution of Income (2005) - where a household's income comes from
  • Income comes from wages/salary, interest, rent, profits

• Personal Distribution of Income (2004) - which group earns household's income
  
  • Divide income earners into 5 classes (quintiles)
    • Lowest 20% are the poor
    • Highest 20% are the rich
      

• Household spending - where does a household's money go
  • Disposable income - income after taxes are taken out
    • Household can spend and/or save disposable income
  • Expenditures
    
    • Durable goods - products that have a life of 3 years or more
    • Automobiles, furniture, computers, etc.
    • Nondurable goods- products that have a life of 3 years or less
    • Food, clothing, and gasoline
    • Services - a service provided to the consumers
    • Attorneys, barbers, doctors, hotels, etc.
      

• Definitions
  • Plant - a physical place such as factory, firm, mine, store, or warehouse
  • Firm - a business that owns the capital
  • Industry - a firm or group of firms that produce a similar product for a market
• Legal Forms of Business
  • Sole Proprietorship - owned by a single individual
    • Owner liable for his business debts
    • Business is dissolved when owner dies
    • Accounts for 72% of business firms
    • Collects 5% of the business revenue
      • Farms
      • Grocery stores
      • Restaurants
  • Partnership - owned by a two or more persons acting as co-owners
    • High risk, because all partners are responsible for debts incurred by 1 partner
    • If one partner dies, then business has to be reorganized
    • Accounts for 8% of business firms
    • Collects 11% of the business revenue
      • Law firms
      • Accounting firms
  • Corporation - owned by stockholders and is a separate legal entity
    
    • Advantages
      
    • Limited liability - if corporation bankrupts, the creditors cannot sue the stockholders The stockholders only lose the value of their stocks
    • Ownership can be easily transferred
      • Easy to buy and sell stock
      • stock - a share of ownership in a corporation
        
      • Theoretically, a corporation can live forever
    • The stockholders elect the board directors who in turn select the managers to run the corporation
    • Corporations can issue a large amount of stocks and bonds
      • bonds- corporation borrows money in its name
      • Corporations can accumulate a large amount of capital
        
    • Problems
      • Corporations can merge and buy other corporations
        • vertically integrated - firms owns or controls all levels of processing
          • Many oil companies extract, transport, refine, and sell petroleum to consumers
        • horizontally integrated (mutliplant) - firm controls production and sales across a market
          • Microsoft controls over 95% of operating systems out there
        • conglomerates - firm controls or produces in several different markets
          • General Electric (GE) owns (or majority shareholder) in NBC Universal, electricity generation, finance, medical equipment.
          • Problem is its focus is too wide spread
            
    • Accounts for 20% of business firms
    • Collects 84% of the business revenue

• Government - public sector and includes federal, state, and municipal governments
  • municipal government is city and county governments
    
• Similarities:
  1. Economic efficiency -   benefits of activity > costs
     • Cost-Benefit Analysis
     • Most value from resources
     • Society benefits
     • Examples:
       • Firm's profits > 0
       • Consumer's marginal utility > 0
     • If benefits < costs, then the activity is inefficient
       • Firm's profits < 0
       • Consumer's marginal utility < 0
     • Government should be efficient, but usually is not
  2. Competitive behavior is present
     • Agencies compete for tax dollars
     • Politicians compete for office
     • Firms compete for customers
  3. Scarcity imposes financial restrictions
     • Total government spending = total taxes collected
       • Government can borrow funds, but borrowing is restricted by future tax increases
     • Total business revenue > total costs
       • A business could earn losses, but only temporary losses
     • "No free lunch"
• Differences:
1. Government sets legal structure, while firms follow rules
   • "Rules of the game"
   • A process for settling disputes
     • Interact peacefully
   • Protect private property against invaders
2. Government can use force to modify human behavior
   • Remove life                 (e.g. death penalty)
   • Remove liberty            (e.g. prison & jails)
   • Seize property             (e.g. taxes, fees, & fines)
3. Government can redistribute wealth and income
• Private market:   A person who buys Coca-Cola drinks the Coca-Cola
  • A person's consumption is linked to his purchases
• Public sector: 
• Transfer payments - transfer income from one group to another group
• Welfare, food stamps, social security, Medicaid, Medicare, college financial aid, etc.
4. Transactions in a private sector is voluntary, while government can use force like paying taxes
• Tax Systems
1. Progressive tax -  Richer households are taxed more heavily than poor households
   • U.S. has a progressive income tax
2. Proporational tax - everyone is charged the same percentage on income
   • Russia and Kazakhstan has a flat tax 
3. Regressive tax - poorer households are taxed more heavily than rich households
• Social security, Medicare, property taxes, sales tax on food, and excise taxes.
5. Government is political
• Democrats versus Republicans
6. Income and power are distributed differently
   • Private sector:   People who supply highly valued goods / services tend to have high incomes.  (1/2 the millionaires earned their fortunes from real estate).
   • Public sector:     Campaigning, fund raising, and public relations help capture voters

• Sum the following:
  1. Government consumes goods, services, and resources 
     • Major resource is labor
       • They could be working in private sector
     • Goods, services, and resources could be used by private sector
  2. Government consumes resources to collect taxes, and enforce government regulations and mandates
     • Cost to prosecute and punish violators
  3. Deadweight loss from taxes and regulations 
     • They cause higher market prices and lower market quantities
       

1.  Lack of Competition:   Sellers collude together to decrease production.  They act like a monopoly.

• Example:  OPEC - reduce the production of oil (i.e. supply function shifts left)
  
  • Acts like a monopoly
  • Monopoly - one firm is the sole supplier/producer in a market
    
    • High market price
    • Low quantity produced
    • High profits

Petroleum Market

2.  Externalities - failure to include all costs and benefits

• Negative externality - an individual's or firm's action harms others without their consent
• Property rights are not defined well
• Not all costs are registered, therefore supply function understates the true cost of production
• Example:  A polluting firm
  • A firm supplies Q* which sell for P* and freely pollutes
  • Pollution is a social cost to society
  • Government can force the firm to include pollution costs, causing the supply function to shift left
    • Taxes, regulations, pollution permits, etc.
    • Equilibrium price increases while quantity supplied decreases
    • This is efficient because firm pays all costs including pollution
    • Firms still pollute, but  less

A Polluting Firm

 

• Positive externality - an individual's actions generate benefits for nonparticipating parties
• Demand functions understates the true value of output
• From the viewpoint of efficiency, too few units may be produced
• Example:  Inoculations - people getting inoculated help prevent the spread of diseases.
  • People who are not inoculated also benefit
  • The market price and quantity is P*and Q* 
  • Government can subsidize inoculations, bringing the market price down  

Market for Innoculations

3.  Public Good - government produces good, because firms have difficulty supplying good through the market.

• Two conditions:
• (i) Every one can consume the good at the same time
  • Also called non-rival
• (ii) Nonexcludable - the good cannot be restricted to the customers who pay for it
  • Payment is not linked to consumption of good
  • Free riders - person has no incentive to pay for public goods
    • Free riders will consume public good, but not help pay for it
• Examples:
  • National defense (military)
  • Radio and television broadcast signals (FCC)
  • Clean air (EPA)
  • Stable monetary and financial environment
    • Federal Reserve System, i.e. central bank.
    • Influences inflation, interest, and foreign exchange rates
    • Controls/creates money supply
    • Regulates private banks, etc  
• Quasi-public goods - market could supply these goods, but the supply would not be enough
  • Postal service
  • Highways
  • Libraries
  • Education
  • Sewage disposal

4.  Poor information

• Asymmetric information - either the buyer or seller has more information than the other side
  • Examples:
    •  A person buys fire insurance, knowing he faulty wiring in his home
    • Credit card companies - calculating interest rates
    • Difficult to inspect good or seldom purchases the good from the same producer
    • Some firms will provide:
      • low-quality
      • defective
      • even harmful goods
• Asymmetric information problem is minimized by purchasing good regularly or through brand names, franchises, and product warranties.

• U.S. Government Receipts - from taxes and fees
  
  • Personal Income Taxes - federal taxes on income
    • Payroll taxes - income taxes are taken out of each paycheck
  • Corporate Income taxes - taxes levied on corporations
    • Double taxation
      • Corporations are taxed on profits
      • Investors are taxed on income as corporations pay dividends
        • Dividends - corporation pays some of its profits to shareholders per share
  • Social Security (FICA) taxes
    • Approximately 8%
    • A matching tax
      • Employee pay approx. 8%
      • Employer matches payment
    • Note - Medicare is a matching tax too!
  • Excise taxes - taxes that are levied on specific products
    • Excise taxes on alcohol, tobacco, and gasoline
    • Not shone because they are small taxes
  • Sales taxes are levied on a variety of goods
    • Usually a percentage on things sold in retail 

• Gross Domestic Product (GDP) - value of all goods & services produced in an economy in one year.
  • "Measure the size of a country"
  • We can see how taxes grow relative to the size of the economy
    

• Government Expenditures (or outlays)
  
  • National Defense - Military spending
  • Payments to people - includes transfer payments
  • Grants to State and Local Governments - federal government gives money to gov.
    • Not free money - many conditions apply
    • A way to get local governments to do what the federal  government wants
  • Interest on U.S. Debt - government borrows money to cover shortfall
    • Net interest on the national debt
    • Government agencies hold approximately 40% of the debt
      

• Government outlays relative to GDP

• U.S. government compared to other countries' governments
  • Europe - ranges from 40% to 60% in 2006
    
    • More socialism
  • Asian - ranges from 17% to 25% in 2006
    
    • Economic growth engines
• State governments - rely on sales, excise, and income taxes
  
  • Education and public welfare are big expenses
• Local governments- rely on property taxes
  • Property tax - government assesses a value on property and collects a percentage of that value every year
  • Majority goes to public education like schools
• Note - seven states do not have an income tax
  • Taxes tend to be smaller, but these states over rely on property taxes and fees
    • Property taxes and fees tend to hit the poor more

My Notes:

• Easy for government to grow in size but difficult to reduce
  • Called Parkinson's Law
• Government tries to find new tax revenue sources
• Bureaucrats have self-interest
  • Maintain their jobs and importance, not necessarily helping people
  • Expand programs
  • Design programs that are long term
  • Justify programs and importance to legislators, i.e. funding

Gov can do great things, but can be oppressive and evil