Economic decision makers LOs Explain the role of the household in the economic system. Identify the different types of firms and describe their roles in the economy. Outline the ways governments affect their economies. Outline the international influences on the economy.

Households Suppliers of economic resources. Buyers of goods and services. Producers of goods and services (household production).

Where U.S. personal income comes from and where it goes Over two-thirds of personal income in 2006 was from wages, salaries, and proprietors income (b) Half of U.S. personal income in 2006 was spent on services

Transfer payments Cash or in-kind benefits given to individuals as outright grants from the government Cash transfers: Social security, disability, unemployment compensation, TANF. In-kind transfers: Medicare, Medicaid, food stamps, school lunch program, subsidized housing.

Household Production Gardening, cooking, ironing, childcare, car repair, painting—many people do these things “in-house.” Household production makes sense if the opportunity cost is less than market price.

The Firm Firms Hire and combine resources Produce goods and services Maximize profit

Types of Firms Sole proprietorship Partnership Corporation Single owner Partnership Two or more owners Corporation Legal entity Shares of stock Limited liability

Number and sales of each type of firm Most firms are sole proprietorships (b) Corporations account for most sales

The Government Establish & enforce rules of the game Promote competition Regulate natural monopolies Provide public goods Deal with externalities More equal distribution of income Full employment Price stability Economic growth

Externalities Examples: Private production and consumption can impose costs on parties “outside the market.” Some costs of production or consumption are thus externalized. Examples: Air, water, noise pollution; cigarette smoke; acid rain; mosquitoes.

Examples of government policy aimed at externalities: In a world where externalities occur, market forces cannot always be relied upon to allocate resources efficiently. This creates a legitimate reason for government regulation. Examples of government policy aimed at externalities: Effluent taxes Pollution “permits” Subsidized vaccinations Auto emission standards Open burning ordinances Smoke free workplaces

Public Goods Public goods are subject to a free-rider problem. A good that, once produced, is available for all to consume regardless of who pays and who doesn’t; such a good is nonrival and nonexclusive. Public goods are subject to a free-rider problem. Examples include lighthouses, flood control, and national defense.

Components of Federal Spending Since 1960

Federal Revenues by Source since 1960

Tax Principles and Tax Incidence Ability-to-pay tax principle Benefits-received tax principle Tax incidence Proportional taxation: Flat tax (as % of income) Progressive taxation: marginal tax rate Top 1% of tax filers – paid 36.9% of taxes Top 10% of tax filers – paid 68.2% of taxes Bottom 50% of tax fillers – paid 3% of taxes Regressive taxation

for income redistribution The tax code is a tool for income redistribution Needy Affluent By making the tax structure “progressive,” governments can make the after-tax distribution of income more equitable (or even).

Why a sales tax is regressive Assume a 7.13 percent excise tax on groceries, gasoline, cigarettes, and liquor Family (1) Income (2) Spending for items subject to excise tax (3) = (2)/(1) (4) Excise Tax Paid (5)= (4)/(1) ATR Greens $27,000 $16,200 .60 $1,188 4.4% Jones 64,000 25,600 .40 1,871 2.9 Lemons 270,000 40,500 .15 2,961 1.0 Moral of the story: Low income families tend to spend a greater proportion of their income on items subject to excise taxes. Hence excise taxes tend to be regressive.

Top marginal rate on federal personal income tax since 1913

The rest of the world Consists of households, firms, and government units in roughly 200 sovereign foreign countries. Foreign agents buy domestically produced goods and services. Domestic agents buy goods and services from foreign producers.

The Global Economy The world is more “integrated” than ever before, as measured by the movement of resources, goods and services between countries

Distribution of global production

Energy Sources in the World Economy

Energy Sources in the World Economy

Energy Sources in the World Economy

Exchange rates An exchange is a price of one (national) currency expressed in terms of another currency.

If the dollar price of the British pound is: 1.45 dollars = 1 pound Then the pound price of the dollar is given by the reciprocal of the dollar-pound exchange rate. That is: Pounds per dollar =