U.S. Private and Public Sectors
Lesson 4

U.S. Private Sector

1. U.S. Households

• 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.

2. U.S. Businesses

• 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

(i) 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

(ii) 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

(iii) 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

Similarities and Differences between Public and Private Sectors

Government - public sector and includes federal, state, and municipal governments

• municipal government is city and county governments

1. 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"

2. 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

The Opportunity Cost of Government

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

Resasons for Government Intervention

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.

Government Statistics

• 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

Terminology