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The Mixed Economy: Private and Public Sectors

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Title: The Mixed Economy: Private and Public Sectors


1
The Mixed EconomyPrivate and Public Sectors
  • Chapter 5

2
I. Goals of the Chapter
  • To describe household and business components of
    the private sector economy.
  • To describe the public sector (or government) in
    the U.S. economy.

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II. Households as Income Receivers
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Personal Consumption
  • Durable goods Expected to last at least 3
    years.
  • Non-durable goods Expected to last less than 3
    years.
  • Services Intangibles

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Composition of Consumer Expenditures, 2002
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IV. Businesses
  • A. Definitions
  • Plant Physical establishment where production
    or distribution takes place.
  • Firm Business organization which owns and
    operates the plants.
  • Industry A group of related firms producing the
    same or similar products.

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Multi-Plant Firms
  • Vertical combination The firm owns plants at
    different stages of production. (Disney)
  • Horizontal combination The firm owns plants
    that produce the same or similar products.
    (Banks)
  • Conglomerate The firm owns plants in different
    industries. (Phillip Morris)

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B. Legal Forms of Businesses
  • Definitions
  • Sole Proprietorship A business owned by a single
    individual.
  • Partnership Two or more individuals own the
    business in a partnership agreement.
  • Corporation A legal entity distinct from its
    individual owners (shareholders). The
    organization acts as a legal person.

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Sole Proprietorship
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Partnership
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Corporations
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Corporations, contd.
  • Financing
  • Equity financing Stocks represent ownership.
    Earn dividends.
  • Common
  • Preferred
  • Debt financing Bonds represent debt. Earn
    interest.
  • Read Last Word, pg. 88

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Corporations, contd
  • Hybrid Structures
  • Taxed like a partnership
  • Limited liability (like a corporation)
  • Limited Liability company (LLC)
  • S corporation

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Corporations, contd.
  • The Principal agent problem
  • In sole proprietorship and partnership the
    owner(s) directly control the firms assets.
  • In large corporations there is a separation of
    ownership and control.
  • A possible conflict of interest occurs when
    managers are hired to run a business on behalf of
    the owners.

21
Corporations, contd.
  • Small numberlarge impact
  • In 1996, 45 U.S corporations had sales over 20
    billion.
  • 143 had sales over 10 billion.
  • G.M. sales 168 billion.
  • Only 22 nations produced more than G.M.
  • All U.S. farm production totaled was less than
    the total sales of the 2 largest corporations.

22
V. Economic Functions of the Government
  • Provide a legal structure
  • Maintain competition
  • Redistribute income
  • Reallocate resources
  • Provide public goods and services
  • Stabilize the economy

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1. Providing the Legal Structure
  • Define ensure property rights
  • Enforcement of contracts
  • Settle disputes
  • Impose penalties for foul play
  • Protection of life and property
  • System of standard weights and measurements
  • Product quality assurance
  • Reliable money supply

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2. Maintaining Competition
  • A firm or small number of firms with monopoly
    power can restrict output and extract higher
    prices.
  • If a natural monopoly exists, government
    regulates price and service.
  • Anti-trust laws are designed to regulate business
    behavior and promote competition.

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3. Redistribution of Income
  • Transfer payments Welfare, unemployment
    compensation, social security, Medicare
  • Market intervention (Price supports) minimum
    wage, farm subsidies, rent controls
  • Federal income tax Takes a larger portion of
    larger incomes (progressive tax).

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4. Reallocation of Resources
  • In a pure market economy, the most efficient use
    of resources occurs automatically.
  • ?The buyer and seller enjoy all the benefits and
    incur all the costs of a transaction.
  • And, resources are allocated to the production of
    all economically justified goods and services.
  • If not ? market failure

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Market Failure
  • Market failure occurs when the competitive market
    system
  • produces the wrong amount of certain goods and
    services (spillovers), or
  • fails to allocate any resources to the production
    of certain goods and services whose output is
    economically justified (public goods).

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Spillovers
  • Spillover costs Production or consumption costs
    inflicted on a third party without compensation.
  • i.e. pollution, 2nd hand smoke, noise
  • The producer does not bear the cost because it is
    passed on to society.
  • Causes over-allocation of resources to the
    production of the good.
  • To correct, the government must get the producer
    to internalize these costs.

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Correcting for Spillover Costs
  • Legislation to limit or prohibit the cost.
  • i.e. catalytic converters, seat belts,
    noise ordinance
  • Taxes
  • i.e. pollution tax which causes firms to
    cut back on pollution and provides funds
    for cleanup.

30
Spillovers, contd.
  • Spillover benefits Occur when the production or
    consumption of a product confers spillover
    benefits to a third party without compensating
    payment.
  • i.e. immunizations, education
  • Individuals who have a demand for the good will
    buy only enough to satisfy their demand.
  • Causes under-allocation of resources.

31
Correcting for Spillover Benefits
  • Government can increase demand by
  • Subsidize consumers.
  • i.e. food stamps, education grants,
  • Subsidize producers.
  • i.e. higher education, immunization program
    s,...
  • Provide goods via government
  • i.e. U.S. Postal Service, public
    schools,...

32
5. Public Goods and Services
  • Private goods
  • Produced through the competitive market system.
  • Divisible Produced in units small enough to be
    purchased and used by individuals.
  • Subject to exclusion principle Buyers who are
    willing and able to pay the market price of the
    product obtain it. Others are excluded

33
Public Goods Services, contd.
  • Public goods
  • Not produced by the competitive market system.
  • Indivisible Cannot ordinarily be sold to
    individuals.
  • Exclusion principle does not apply. (The
    free-rider problem)
  • Classic example A lighthouse

34
Quasi-Public Goods Services
  • Subject to the exclusion principle.
  • ?they could be produced by private firms.
  • They produce large external benefits.
  • ?the market system would under-produce.
  • Examples education, roads, police/fire
    protection, libraries, museums

35
Allocation of Resources to Public and
Quasi-public Goods
  • Purchased through government by group, or
    collective, choice.
  • i.e. voting for a candidate whose priorities
    for spending most closely match yours.
  • Resources are reallocated from private to public
    use by taxing households and businesses.

36
Reallocation of Resources Through Taxes
  • Government taxes households businesses
  • Households businesses have less money to spend
    on G S
  • Firms produce less G S
  • Lower production reduces use of resources by the
    private sector
  • More resources available for public use

37
6. Stabilizing the Economy
  • Full employment of resources.
  • - low unemployment rate
  • Stable prices
  • - low rate of inflation

38
VI. The Circular Flow (again??)
  • Review Fig. 2-6, pg. 34
  • Compare to Fig. 5-6, pg. 84

39
VII. Government Finance
  • 1. Government purchases
  • Exhaustive products purchased directly absorb
    resources and are part of domestic output. Ex
    police car
  • 2. Transfer payments
  • Non-exhaustive do not directly absorb resources
    or account for production.
  • Ex social security, welfare

40
Government Growth
  • Fig. 5-7, pg. 85
  • 1960 Total government spending ? 26 of domestic
    output (GDP).
  • Purchases ? 21, transfers ? 5
  • 2002 Total government spending ? 30 of GDP.
  • Purchases ? 18, transfers ? 12

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Personal Income Tax
  • Levied on taxable income (gross income
    exemptions/deductions).
  • Progressive tax
  • Marginal tax rate
  • Average tax rate total tax paid /total taxable
    income

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Payroll Taxes
  • Taxes based on wages and salaries (other than
    income tax).
  • Used to finance Social Security Medicare
  • Proportional tax
  • 2003 employees employers each paid 7.65 of
    the first 87,000, and 1.45 of all additional
    earnings.

46
Federal Taxes, contd.
  • Corporate income tax Levied on a corporations
    profit (total revenue total costs). Rate 35
    for most corporations.
  • Excise tax Levied on specific products
  • Gasoline, tobacco, alcoholic beverages

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State Local Finance
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Fiscal Federalism
  • The system of intergovernmental transfers
  • Grants from the federal to state/local
    governments.
  • Grants from state to local governments.
  • Represents 15 to 20 percent of all state local
    revenue.

53
Lotteries
  • Critics
  • gambling ? morally wrong
  • people become addicted
  • regressive
  • attract criminal element
  • luck and fate rather than education and hard
    work lead to success

54
Lotteries, contd.
  • Supporters
  • Preferable to taxes voluntary
  • Painless way to finance government
  • Compete with illegal gambling helps fight
    organized crime

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The End
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