Up Coming Stuff Quiz Chapter 5 Friday, 10/14 Bonus Work Chapter 5 Monday, 10/17 All homework Chapters 4 & 5 Tuesday, 10/18 Review Wednesday, 10/19 Test.

Up Coming StuffUp Coming Stuff

•Quiz Chapter 5 Friday, 10/14

•Bonus Work Chapter 5 Monday, 10/17

•All homework Chapters 4 & 5 Tuesday, 10/18

•Review Wednesday, 10/19

• Test on Chapter 4 & 5 – Thursday, 10/20!

GHSEnglishDept.

Pure Capitalism to Mixed Economy.Pure Capitalism to Mixed Economy.• If you could choose anywhere in the world to live where

would it be and why????• If you had to rate countries in the world in terms of their

standards of living what characteristics would you use and why?

• The next chapter begins to look at how the government intervenes in an economic system to allocate resources.

• Chapter 5 gets us into some debatable issues dealing with tax rates, subsidies, social equality etc.. Does the government hurt or help??

• While watching the video look for those issues we have talked about with reference to how a capitalist economy works best.

• Also look for the policies of the government that lead to inefficiencies.

THE CIRCULAR FLOW REVISITEDTHE CIRCULAR FLOW REVISITED

BUSINESSESBUSINESSESsubsidysubsidy

HOUSEHOLDSHOUSEHOLDSFICAFICA

RESOURCERESOURCEMARKETMARKET

RESOURCESRESOURCES INPUTSINPUTS

$ COSTS$ COSTS $ INCOMES$ INCOMES

PRODUCTPRODUCTMARKETMARKET

GOODS &GOODS &SERVICESSERVICES

$ CONSUMPTION$ CONSUMPTION$ REVENUE$ REVENUE

Tax PaymentsTax PaymentsGOVERNMENTGOVERNMENT

private propertyprivate property

freedom of enterprisefreedom of enterprise

freedom of choicefreedom of choice

self-interestself-interest

competitioncompetition

roundabout productionroundabout production

specializationspecialization

division of labordivision of labor

medium of exchangemedium of exchange

barterbarter

moneymoney

Five Fundamental QuestionsFive Fundamental Questions

economic costseconomic costs

normal profitnormal profit

economic profiteconomic profit

expanding industryexpanding industry

declining industrydeclining industry

consumer sovereigntyconsumer sovereignty

dollar votesdollar votes

derived demandderived demand

guiding function of pricesguiding function of prices

““invisible hand”invisible hand”

The Mixed Economy:The Mixed Economy:The Mixed Economy:The Mixed Economy:Private and Public SectorsPrivate and Public SectorsPrivate and Public SectorsPrivate and Public Sectors

CHAPTER FIVE

The Seven Roles of Government:The Seven Roles of Government:1. Maintain Competition

2. Protect Private Property (Life & Liberty)

3. Stabilize the Economy

4. Provide Public Goods:(Pure Private, Common Pool, Toll Goods, Pure Public)

5. Control Externalities/Spillovers: (Pollution Control v Schools)

6. Taxes – Redistribute Income

FUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTION WAGESWAGES RENT RENT

INTERESTINTEREST PROFIT/LOSSPROFIT/LOSS

HOUSEHOLDS AS INCOME RECEIVERSHOUSEHOLDS AS INCOME RECEIVERS

FUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTION WAGESWAGES RENT RENT

INTERESTINTEREST PROFIT/LOSSPROFIT/LOSSPERSONAL DISTRIBUTIONPERSONAL DISTRIBUTIONPERSONAL DISTRIBUTIONPERSONAL DISTRIBUTION

SHOWS ALLOCATION OF SHOWS ALLOCATION OF INCOME AMONG INDIVIDUAL INCOME AMONG INDIVIDUAL

HOUSEHOLDSHOUSEHOLDS

I. How to measure economic activity?

• A. Functional Distribution of Income• 1. Measures wages, profits, interest and rent.• 2. Profits are divided into two categories.• - proprietors income – profits of those

self-employed, doctors, lawyers, farmers.• - Capitalist income or corporation

income/ profits.

WAGES $7,103 Billion 71%

PROPRIETOR’S INCOME 900 Billion 8%CORPORATE PROFITS 1,400 Billion 12%INTEREST 700 Billion 7%

RENTS 200 Billion 2%

FUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTION

WAGES $7,103 Billion 70%

PROFITS $2,349 Billion 21%

INTEREST $750 Billion 7%

RENT $200 Billion 2%

FUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTIONFUNCTIONAL DISTRIBUTION

2004 GDP2004 GDP

WEASEL PUSS IS RED!

$10,402 Billion

I. How to measure cont…I. How to measure cont…

• B. Personal Distribution of Income• 1. Indicates how much total income is divided

among household units.• 2. The government uses this as a reference to

how equitable or inequitable income is distributed in the U.S.

• 3. The Lorenz Curve is a mathematically derived index of income inequality.

PERSONAL DISTRIBUTIONPERSONAL DISTRIBUTIONPERSONAL DISTRIBUTIONPERSONAL DISTRIBUTIONPersonal Income Received (Percent)Personal Income Received (Percent)

4.2%4.2%

10.0%10.0%

14.8%14.8%

22.1%22.1%

49.8%49.8%

Lowest 20% Income GroupLowest 20% Income Group

Second 20% Income GroupSecond 20% Income Group

Middle 20% Income GroupMiddle 20% Income Group

Highest 20% Income GroupHighest 20% Income Group

Fourth 20% Income GroupFourth 20% Income Group

2004 US Census Bureau

Share of Income - HistoricallyShare of Income - Historically

Year Lowest 20%

Next 20%

Middle20%

Next 20%

Highest 20%

1968 4.2 11.1 17.5 24.4 42.8

1982 4.1 10.1 16.6 24.7 44.5

1992 3.8 13.4 15.8 24.2 46.9

2001 3.5 8.7 14.6 23.0 50.1

The Lorenz Curve

20 40 60 80 100

Percent of Families

e Perfect EqualityPerfect Equality

CompleteCompleteInequalityInequality

Copyright McGraw-Hill, Inc. 1999

The Lorenz Curve

20 40 60 80 100

Percent of Families

Lorenz CurveLorenz Curve (actual distribution)(actual distribution)

The Lorenz Curve

20 40 60 80 100

Percent of Families

Area betweenthe lines shows

the degree ofincome inequality

The Lorenz Curve

20 40 60 80 100

Percent of Families

Two Adjustments:Two Adjustments:

TaxesCash Transfer Payments

30 40 50 60 70

GLOBAL PERSPECTIVEGLOBAL PERSPECTIVE

Percentage of total income earned by top fifth of income receivers

BrazilSouth Africa

GuatemalaMexico

United KingdomUnited States

JapanNorway

BrazilSouth Africa

GuatemalaMexico

United KingdomUnited States

JapanNorway

Percentage of total income earned by top 20% of income receivers

BrazilSouth Africa

GuatemalaMexico

United StatesUnited Kingdom

JapanNorway

BrazilSouth Africa

GuatemalaMexico

United StatesUnited Kingdom

JapanNorway

30 40 50 60 70

GLOBAL PERSPECTIVEGLOBAL PERSPECTIVE

Executive Pay in someUS. Industries is300 Times Higherthan an Average Worker’s Salary.

1 - Demand for Highly Skilled Workers 1 - Demand for Highly Skilled Workers

2 - Demographic Changes2 - Demographic Changes

3 - International Trade & Pressures 3 - International Trade & Pressures - Immigration + Illegal Immigration- Immigration + Illegal Immigration- Union Decline- Union Decline

The Lorenz Curve AP Test 2004The Lorenz Curve AP Test 2004graphically...

Causes of Growing InequalityCauses of Growing Inequality

Wage Data 138,000,000US Workers

• 100,000,000 full time US workers in 2001 earned less than $35,000/yr.

• 84% earned less than $65,000

• 10% earned between $65,000 and $100,000

• 5.7% earned more than $100,000US News and World Report

Wage Data – Median Incomefor a Person

• Median Income: $33,636• Only 32.8% of all US

jobs paid over $45,000• Two-thirds of all wage

earners work two jobs• Two-thirds of all mothers

with children now work• Median paycheck for

working wives: $18,000

US News and World Report

Median Household Income: 2003 Median Household Income: 2003 • USA Median Household Income: $42,409• Half of US households earn more and half of US households earn less• 1999 Peak Median US Income: $43,915• Wisconsin: $45,985• Half of WI households earn more and half of WI households earn less

Source: US Census Bureau

Working MothersWorking Mothers

• 71.1 percent of mothers work

• 53.7 percent of mothers with children under 1 year work

• Unemployment Rate for unmarried mothers with children under age 18: 10.3%– Jobless Rate 20.5%

Vote KerryBush

Working PoorWorking Poor

• Of the 46,000,000 Americans who are not yet married, median earnings $17,000

• For single women-head of households, median income: $18,472

39,000,000 Working Poor39,000,000 Working Poor

• One in five full time 40 hr./week US jobs pays below the poverty-line $18,244 for a family of four

• 20,000,000 children live in families with incomes below the poverty line

Milwaukee Journal

28,000,000 Jobs28,000,000 Jobs

• 28,000,000 service jobs pay less than $8.84

• $8.84 is the hourly rate that matches the poverty-line $18,244

Milwaukee Journal

Helping the 39,000,000 Working Poor

• Suggested Solutions???• Adult Education!• Job Training• Increased Minimum Wage• Subsidize Child Care for

low income workersHelp isOn the

Milwaukee Journal

$36,388 – Low Income Family$36,388 – Low Income Family

• A family of four living on an annual income of $36,388 is considered to be a low income family

• A family of four living on an annual income of $18,244 is considered to be living in poverty.

Milwaukee Journal

Median Incomes US FamiliesMedian Incomes US Families

• White: $47,800

• Hispanic: $33,000

• African American: $29,600

Milwaukee Journal

Median Family Net WorthsMedian Family Net Worths

• White Families: $88,000 up 17% since 1996

• Hispanic Families: $8,000 up 14% since 1996

• African American Families: $6,000 down 16% since 1996

Milwaukee Journal

The Lorenz Curve

20 40 60 80 100

Percent of Families

1 - Ability Differences1 - Ability Differences2 - Education and Training2 - Education and Training3 - Discrimination3 - Discrimination4 - Tastes and Risks4 - Tastes and Risks5 - Unequal Distribution of Wealth5 - Unequal Distribution of Wealth6 - Market Power6 - Market Power7 - Luck, Connections, and Misfortune7 - Luck, Connections, and Misfortune

EQUALITY-EFFICIENCY TRADEOFFEQUALITY-EFFICIENCY TRADEOFF

CAUSES OF INCOME INEQUALITYCAUSES OF INCOME INEQUALITY

Labor Market TheoryThe Real World Will Get You!

• Human Capital– Education = Income

• Sorting Mechanism–Hoops

• Radical View–Rich Dad Poor Dad

• Dual Labor Market–Good Job v Bad Job Market

Family Income USAFamily Income USA

• 9.8% $100,000+• 8.9% $75-99,999• 19% $50-74,999• 16.3% $35-

49,999• 13% $25-34,999• 14.4% $15-

24,999• 18.6% <$15,000

Family Income Distribution2001

Family Income Distribution2001• $355,000

– Top 1%

• $130,600– Top 5%

• $93,800– Top 10%

• 60,800– Top 25%

• 33,400– Top 50%

38,500,000+: Men, Women, and Children(13.1%)

The typical poor person in the US:• Single Mom with Kids!• White unemployed female under forty• Found everywhere including Ozaukee County (2200+)!

$18,810 for a family of four!$12,015 for a family of two!$9,573 for a single person!!

Of the 200 largest US counties Waukesha with 3.0% of its residents in Poverty ranked second lowest in the US.

Of all 5,700+ US counties Ozaukee with 2.2% of itsResidents in Poverty ranked third lowest in the US.

Wisconsin PovertyWisconsin Poverty

• 528,000 people or 9.8% of WI residents

• WI residents without health insurance 593,000

• National rank 36th lowest poverty in poverty rate

Poverty in America: 2003 DataPoverty in America: 2003 Data

• 37.6 Million Americans– Up 1.7 million from 2002– 12.1 million are children

• 12.1% of Americans• Wisconsin’s poverty rate

2003: 8.2%• Poverty Line 2003:

– $18,244 for a family of 4– $9,359 for a single person

Source: US Census Bureau, Journal/Sentinel

State Rankings on PovertyFamilies Living Below the Poverty Line

1. Mississippi 16.0%

2. Louisiana 15.8%

3. New Mexico 14.5%

4. West Virginia 13.9%

5. Kentucky 12.7%

46. Iowa 6.0%

47. Connecticut 5.6%

48. Wisconsin 5.5%

49. Minnesota 5.1%

50. New Hampshire 4.3%

Total US Poor:32,500,000

Average Per State:9.2%

State Rankings on Families Receiving WelfareState Rankings on Families Receiving Welfare

1. Alaska 8.7%

2. Hawaii 7.2%

3. Oklahoma 5.1%

4. California 4.9%

5. New York 4.9%

46. Maryland 2.4%

47. Kansas 2.36%

48. Nevada 2.35%

49. Alabama 2.24%

50. Wisconsin 1.71%

Total Welfare Recipients:

Less than 22,000,000

The Working PoorThe Working Poor

• Income less than $8.00/Hour

• Yearly incomes less than $25,000 for a family of 4

• 30% of Americans: 74,000,000 people!

• Uninsured Americans 58,000,000

HELPHELP

WANTEDWANTED

The Working PoorThe Working Poor• Hourly wages needed

to afford a One Bedroom Apartment– $8.89

• Chance of a Welfare Recipient getting a $8.89/Hour Forty Hour/Week Job?– 97 to 1

Want Ads

Data: National Coalition for the Homeless

Functional Distribution of Income

WagesPro IncCorp IncInterestRent

How is the 10.4 TrillionDollars earned in theEconomy?

PERSONAL DISTRIBUTIONPERSONAL DISTRIBUTIONPERSONAL DISTRIBUTIONPERSONAL DISTRIBUTIONPersonal Income Received (Percent)Personal Income Received (Percent)

4.2%4.2%

10.0%10.0%

14.8%14.8%

22.1%22.1%

49.8%49.8%

Lowest 20% Income GroupLowest 20% Income Group

Second 20% Income GroupSecond 20% Income Group

Middle 20% Income GroupMiddle 20% Income Group

Highest 20% Income GroupHighest 20% Income Group

Fourth 20% Income GroupFourth 20% Income Group

How is that income allocated??? What is in societies best interest???

C. Household Income! Disposal Spending+Saving+Taxes=GDP

• W+P+i+R • Weasel puss is red• 1. All Income is spent

or saved or lost to taxes!

• What is the distribution of spending, saving, and taxes?

Another way to measure!!!

1997 DATA1997 DATA

HOUSEHOLDS AS SPENDERSHOUSEHOLDS AS SPENDERS

WHERE DOES OUR INCOME GO?WHERE DOES OUR INCOME GO?WHERE DOES OUR INCOME GO?WHERE DOES OUR INCOME GO?

to personal savings to personal savings

Milwaukee Journal

1997 DATA1997 DATA

6%6% to personal taxes excludingto personal taxes excludingSocial SecuritySocial Security

Affective tax rate for Americans:Affective tax rate for Americans:14% + 7.5% = 21.5%14% + 7.5% = 21.5%

Taxes as % of GDP = 29.9%Taxes as % of GDP = 29.9%

14%14%

Taxes as a Percent of GDPTaxes as a Percent of GDP

• Sweden 56.1%

• Denmark 49.9%• Netherlands 46.0%• Belgium 44.3%• France 43.8%• Austria 41.0%• Germany 38.1%• Italy 37.8%

• Ireland 37.6%• Britain

36.5%• Canada 35.3%• Spain 34.4%• Greece 33.2%• Japan 30.6%• Australia 30.1%• USA 29.9%

Source OECD

1997 DATA1997 DATA

6%6% to personal consumptionto personal consumption14%14% 80%80%

SAVINGS

ConsumerSpending about80% of income

1997 DATA1997 DATA

NOTES:NOTES:NOTES:NOTES:Spending ClassificationsSpending Classifications

1- Durables 12%1- Durables 12%

1997 DATA1997 DATA

1- Durables1- Durables1- Durables1- Durables

2- Nondurables 30%2- Nondurables 30%

1997 DATA1997 DATA

1-Durables 12%1-Durables 12%1-Durables 12%1-Durables 12%

2-Nondurables 30%2-Nondurables 30%2-Nondurables 30%2-Nondurables 30%

3-Services 58%3-Services 58%

II. Business OrganizationsPlant – Firm - Industry

Proprietorships

Partnerships

Corporations

Hybrids

THE BUSINESS POPULATIONTHE BUSINESS POPULATION

A. Terminology....A. Terminology....

1- PLANT1- PLANT1- PLANT1- PLANT

One LocationOne Location

2- FIRM2- FIRM2- FIRM2- FIRMOne businessOne business

organization - Mayorganization - Mayhave one or have one or more plantsmore plants

One businessOne businessorganization - Mayorganization - May

have one or have one or more plantsmore plants

Terminology....Terminology....

2- FIRM2- FIRM2- FIRM2- FIRM

NOTES:NOTES:

VerticalVerticalCombinationsCombinations

NOTES:NOTES:

Horizontal Horizontal CombinationsCombinationsHorizontal Horizontal

CombinationsCombinations

VerticalCombinations

NOTES:NOTES:

Horizontal Combinations

VerticalCombinations

ConglomeratesConglomeratesConglomeratesConglomerates

3- INDUSTRY3- INDUSTRY3- INDUSTRY3- INDUSTRY

B. US Business OrganizationsB. US Business Organizations

• Proprietorships 75% 17,000,000

• Partnerships 7% 1,500,000

• Corporations 18% 4,000,000

• Hybrids/Corps 500,000

23,000,000

1. Type of Business Percent of Market Total Number

(Both Bush and VP Dick Cheney claimed in the last year’s debates that 900,000 "small businesses" would be hurt by restoration of taxes on $200,000+ incomes.)

Small Businesses USSmall Businesses US• The United States Small Business Administration

classifies companies with fewer than 500 employees as "small." There are more than 5 million such businesses that have payrolls, and they employ about half of the nation's private-sector workers. Of those 5 million firms, 4.3 million have fewer than 20 employees each. The small business owner's reputation as underdog and risk-taker is a hard-earned one. Every year sees 600,000 to 800,000 companies start up, just as 500,000 or so go under.

• Let's give credit where credit is due. Bush has cut taxes for all Americans, which has helped small business owners continue to generate 60 to 80 percent of all new jobs annually. (US Chamber of Commerce)

B. US Business OrganizationsB. US Business Organizations

• Proprietorships 6%

• Partnerships 5%

• Corporations 89%

2. Type of Business Percent of Market Sales

Top 10 US Corporations by RevenuesTop 10 US Corporations by Revenues

1. Wal-Mart $217,799,000,000

2. Exxon Mobile $187,510,000,000

3. General Motors $177,260,000,000

4. Ford Motor $162,412,000,000

5. General Electric $125,679,000,000

6. Citigroup $112,022,000,000

7. Chevron Texaco $106,245,000,000

8. Philip Morris $89,942,000,000

9. IBM $85,866,000,000

10. Microsoft $83,654,000,000

Top 10 International Corporations by RevenuesTop 10 International Corporations by Revenues

1. Wal-Mart $217,799,000,000

2. Exxon Mobile $187,510,000,000

3. Shell $177,281,000,000

4. General Motors$177,260,000,000

5. Ford Motor $162,412,000,000

6. Daimler Chrysler $152,446,000,000

7. BP $148,062,000,000

8. General Electric$125,679,000,000

9. Citigroup$112,022,000,000

10. Mitsubishi $110,787,000,000

C. LEGAL FORMS OF BUSINESS C. LEGAL FORMS OF BUSINESS ENTERPRISESENTERPRISES

1. Sole Proprietorship1. Sole Proprietorship

•Easy to OrganizeEasy to Organize•Proprietor is Own “Boss”Proprietor is Own “Boss”

Advantages...

1. Sole Proprietorship1. Sole Proprietorship

•Easy to OrganizeEasy to Organize•Proprietor is Own “Boss”Proprietor is Own “Boss”

Advantages...

Disadvantages...•Limited ResourcesLimited Resources•No Help With Decision MakingNo Help With Decision Making•Unlimited LiabilityUnlimited Liability

2. Partnership2. Partnership

Advantages...•Also Easy to OrganizeAlso Easy to Organize•More Management SkillsMore Management Skills•Greater Resources AvailableGreater Resources Available

2. Partnership2. Partnership

Disadvantages...

Advantages...•Also Easy to OrganizeAlso Easy to Organize•More Management SkillsMore Management Skills•Greater Resources AvailableGreater Resources Available

•Difficulty Making DecisionsDifficulty Making Decisions•Possibly Limited Financial ResourcesPossibly Limited Financial Resources•Partnership Continuity ProblemsPartnership Continuity Problems•Unlimited LiabilityUnlimited Liability

3. Corporation3. CorporationAdvantages...

•Most Effective Raising Capital - Stocks, Bonds Most Effective Raising Capital - Stocks, Bonds •Limited Liability******Limited Liability******•Easy Expansion of Size & ScopeEasy Expansion of Size & Scope•Infinite LifeInfinite Life

CorporationCorporationAdvantages...

•Most Effective Raising Capital - Stocks, Bonds Most Effective Raising Capital - Stocks, Bonds •Limited LiabilityLimited Liability•Easy Expansion of Size & ScopeEasy Expansion of Size & Scope•Infinite LifeInfinite Life

Disadvantages...•Corporate Regulations & Legal ExpensesCorporate Regulations & Legal Expenses•Some Unscrupulous PracticesSome Unscrupulous Practices•Double TaxationDouble Taxation•Separation of Ownership & ControlSeparation of Ownership & Control

LEGAL FORMS OF BUSINESS ENTERPRISESLEGAL FORMS OF BUSINESS ENTERPRISES

CorporationCorporationAdvantages....

Disadvantages•Corporate Regulations & Legal ExpensesCorporate Regulations & Legal Expenses•Some Unscrupulous PracticesSome Unscrupulous Practices•Double TaxationDouble Taxation•Separation of Ownership & ControlSeparation of Ownership & Control

NOTES:NOTES:

Principal-Agent

Problem

Principle Agent ProblemPrinciple Agent Problem

• Partnership and Proprietorship the owner/owners is/are the principle agents!

• Corporate America has a board of directors and CEO that serve as the principle agents for stockholders!Ken Lay – CFO Enron

10 Highest Paid CEO’s in the US December 200110 Highest Paid CEO’s in the US December 20011. Michael Dell Dell Computers $235,192,000

2. Sanford Weill Citigroup $216,183,000

3. Gerald Levin AOL Time Warner $164,388,000

4. John Chambers Cisco Systems $157,305,000

5. Henry Silverman Cendant $137,447,000

6. Louis Gerstner Jr. IBM $103,410,000

7. Joseph Nacchio Qwest Com. $97,387,000

8. Walter Sanders Advanced Micro $92,246,000

9. Steven Jobs Apple Computers $90,000,000

10. Jeffery Skilling Enron $84,449,000

CorporationsCorporations

• 90% of Revenue• 80% of Output• Wal-Mart’s revenue

greater than the GDP of 170 nations

• Wal-Mart and GM combined revenues exceed total revenue of all US farms combined

CorporationCorporationAdvantages...

Disadvantages...•Corporate Regulations & Legal ExpensesCorporate Regulations & Legal Expenses•Some Unscrupulous PracticesSome Unscrupulous Practices•Double TaxationDouble Taxation•Separation of Ownership & ControlSeparation of Ownership & Control

LEGAL FORMS OF BUSINESS ENTERPRISESLEGAL FORMS OF BUSINESS ENTERPRISES

CorporationCorporationAdvantages....

Disadvantages•Corporate Regulations & Legal ExpensesCorporate Regulations & Legal Expenses•Some Unscrupulous PracticesSome Unscrupulous Practices•Double TaxationDouble Taxation•Separation of Ownership & ControlSeparation of Ownership & Control

NOTES:NOTES:

Limited-Liability

Companies(LLCs)(LLCs)

4. Hybrids4. Hybrids

• LLC– Taxed like a

partnership– Limited Liability like a

corporation

• S-Corporations– Fewer than 35

employees– Limited liability– No double taxation

III. Five Major Roles of Government in a Capitalist

Economy

III. Five Major Roles of Government in a Capitalist

Economy• Provide Social and

Legal Framework• Maintain Competition• Redistribute Income• Correct Market Failure• Stabilize the Economy

A. LEGALA. LEGALANDAND

SOCIALSOCIALFRAMEWORKFRAMEWORK

ECONOMIC FUNCTIONS OF GOVERNMENTECONOMIC FUNCTIONS OF GOVERNMENT

1. Seeks to strengthen the market system.

B. MAINTAININGB. MAINTAININGCOMPETITIONCOMPETITION

“Microsoft willRule the World!’

Bill Gates 2002

MAINTAININGMAINTAININGCOMPETITIONCOMPETITION

Notes:Notes:1.MONOPOLY- illegal1.MONOPOLY- illegal

Notes:Notes:1.MONOPOLY- illegal

2. NATURALMONOPOLIES2. NATURALMONOPOLIES

Notes:Notes:1. MONOPOLY- illegal

2. NATURALMONOPOLIES

MARKET BIASES &SHORTCOMINGS CAN COMPEL ACTION BYGOVERNMENT

C. REDISTRIBUTIONC. REDISTRIBUTIONOF INCOME....OF INCOME....

1. Transfer Payments1. Transfer Payments

Of $10,000.00 Paid in Federal Income Tax: $2,620.00 goes to the military$2,260.00 goes to pay the interest on

the national debt$1,900.00 goes to health care $550.00 goes to income security $340.00 goes to benefits for veterans $320.00 goes to education $250.00 goes to nutrition spending $160.00 goes to housing $160.00 goes to the environment $40.00 goes to job training$1,400.00 goes to all other expenses

ExcludesFICA @7.5%

Ten Largest Militaries in the WorldTen Largest Militaries in the World

1. China 2,340,000

2. US 1,365,800

3. India 1,303,000

4. North Korea 1,082,000

5. Russia 1,004,000

6. South Korea 683,000

7. Pakistan 612,000

8. Turkey 609,000

9. Iran 513,000

10. Vietnam 484,000

Total US Military Spending:

$352,000,000,000

Top Military SpendersTop Military Spenders1. USA $352,000,000,000

2. Japan $46,700,000,000

3. Britain $36,000,000,000

4. France $33,600,000,000

5. China $31,100,000,000

6. Germany $27,700,000,000

7. Saudi Arabia $21,600,000,000

8. Italy $21,100,000,000

9. Iran $17,500,000,000

10. South Korea $13,500,000,000

11. India $12,900,000,000

12. Russia $11,400,000,000

The sum of spending by the other top 25 countries does not equal US spending!

Countries with the Highest Life Expectancy

1. Japan 81.5 yrs.

2. Sweden 80.1 yrs.

3. Iceland 79.4 yrs.

4. Australia 79.2 yrs.

5. Israel 79.2 yrs.

6. Martinique 79.1 yrs.

7. Switzerland 79.1 yrs.

8. Canada 79.0 yrs.

9. France 79.0 yrs.

10. Norway 78.9 yrs.USA 77.5Worldwide 66.0

1. Transfer Payments1. Transfer Payments

2. Personal Income Tax2. Personal Income Tax

Taxes in the USATaxes in the USA

• 3. Theories of Taxation:– Ability to Pay– Benefits Received

• 4. Types of Taxes:– Progressive– Proportional– Regressive

Apportioning the Tax BurdenApportioning the Tax Burden

Benefits-Received PrincipleBenefits-Received Principle

Benefits-Received PrincipleBenefits-Received PrincipleAbility-to-Pay PrincipleAbility-to-Pay Principle

• Progressive Tax & Progressive Tax & Marginal Tax Rates!Marginal Tax Rates!

Progressive TaxProgressive Tax

• The fraction of income paid in taxes increases as a person’s income increases.

• Marginal tax rate - rate at which the tax is paid on each additional unit of income.

• Example - Earning $50,000 – What do you pay in taxes given the following rates?

• 1 – 41,200 15%

• 41,201 – 99,600 28%

• 99,601 – 151,750 31%

• 151,751 – 271,050 36%

• 271,050 - 39.6%

$8,644What is your average tax??

• Progressive Tax• Regressive TaxRegressive Tax

• Progressive Tax• Regressive Tax• Proportional TaxProportional Tax

Proportional and RegressiveProportional and Regressive

• Proportional is a tax where the fraction of income paid in taxes remains constant as a person’s income increases. A flat tax.

• Regressive is a tax where the fraction of income paid in taxes increases the lower your income.

• Sales taxes are what seem to be a proportional tax but indeed are regressive.

• Example Family 1 Family of 4 Family 235,000 75,000 5,000 Food expenses 5,000

6% tax rate – flat tax 6%

$300 tax paid $300 .8% of income .4%

Tax Applications:Tax Applications:

• Personal Income TaxPersonal Income Tax• Sales TaxSales Tax• Corporate Income TaxCorporate Income Tax• Payroll TaxesPayroll Taxes• Property Taxes Property Taxes

Identify whether progressive, regressive, or proportional

Taxes as a Percent of GDPTaxes as a Percent of GDP• Sweden

56.1%• Denmark 49.9%• Netherlands 46.0%• Belgium 44.3%• France 43.8%• Austria 41.0%• Germany 38.1%• Italy 37.8%

• Ireland 37.6%• Britain

36.5%• Canada 35.3%• Spain 34.4%• Greece 33.2%• Japan 30.6%• Australia 30.1%• USA 29.9%

Source OECD

•1. Transfer Payments1. Transfer PaymentsFICA to PeopleFICA to People

5.5. Market InterventionMarket Intervention Minimum wages and subsidies.Minimum wages and subsidies.

• 2-4. Taxes2-4. Taxes

D. REALLOCATION OF RESOURCES....D. REALLOCATION OF RESOURCES....

1. The government will intervene when it feels a market failure has taken place.

2. The market produces the wrong type or amount of goods.

3. The market fails to allocate any resources for the production of a good.

D. REALLOCATION OF RESOURCES....D. REALLOCATION OF RESOURCES....4. Spillovers or Externalities4. Spillovers or Externalities

- Spillover Costs

When a producer avoids someof the costs of producinga product.

Example – pollution

A larger output is produced than is socially acceptable.

REALLOCATION OF RESOURCES....REALLOCATION OF RESOURCES....Spillovers or ExternalitiesSpillovers or Externalities

Spillover Costs

- Correcting For Spillover Costs

•Legislation Legislation

Spillover Costs

Correcting For Spillover Costs

•LegislationLegislation•Specific TaxesSpecific Taxes

Correcting for Spillover CostsCorrecting for Spillover CostsCorrecting for Spillover CostsCorrecting for Spillover Costs

SpilloverSpillovercostscosts

OverallocationOverallocation

s + Tax

Price too Low!

Qd = Qs

Amount ofTax neededto correctNegative externality!

New market price paid by consumers

Correcting for Spillover CostsCorrecting for Spillover CostsCorrecting for Spillover CostsCorrecting for Spillover Costs

SpilloverSpillovercostscosts

S + Tax

TAXTAXTo FixTo FixSpillover costSpillover cost

Overallocation CorrectedOverallocation Corrected

TaxConsumer pays

Producer Receives

Spillover BenefitsThe Underallocation of Resources

You don’t directly get all the utility or receive all the benefits,so you don’t consume as much as you could if you didreceive all of the benefits.

Example - Education

Spillover Benefits

Correcting for Spillover Benefits....

• Increase Demand

Correcting for Spillover BenefitsCorrecting for Spillover BenefitsCorrecting for Spillover BenefitsCorrecting for Spillover Benefits

D + Subsidy

SpilloverSpilloverBenefitsBenefits

UnderallocationUnderallocationCorrectionCorrection

Initiallypriced toolow!!!

Federal Grants for Education

D + Subsidy

SubsidySubsidyto consumerto consumer

UnderallocationUnderallocationCorrectedCorrected

Amount of the subsidy needed to correct externality!

Price isIncreased!

Spillover Benefits

• Increase Demand• Increase Supply

SubsidySubsidyto producersto producers

S + Subsidy

SubsidySubsidyto businessto business

UnderallocationUnderallocationCorrectedCorrected

Price for consumersfalls

Madison costs less than Marquette

Spillover Benefits

• Increase Demand• Increase Supply• Government Provision

5. Ownership Rights5. Ownership Rights

• Some goods need to be produced because they produce a societal benefit but would not be produced if the gov’t did not intervene.

• In order to determine when the gov’t should intervene they classify goods according to categories.

• Exclusion principle - One of the main determining factors is if the good will be adequately produced in the market. Does the purchaser have an exclusive right to that good?

Pure Private GoodsPure Private Goods

• No Shared Consumption!

• Exclusion permitted!

• Hands off my burger!!

• Depletability

Toll GoodsToll Goods

• You pay to use a resource

• Using the resource doesn’t deplete its supply or usefulness

• You may be denied use if you fail to pay

• Applies to private goods

Pure Public GoodsPure Public Goods

• Indivisible – too large for individuals to consume.

• Free Rider Problem• The benefits to one

user does not exceed the cost!

• Highways, space shuttle, aircraft carrier

Private Goods:Private Goods:Divisibility &Divisibility &DepletabilityDepletability

Public Goods:Public Goods:

Indivisible Indivisible

Public or Social Goods Are...

IndivisibleSubject to the free-rider problem

May Provide Large SpilloverBenefits

Quasi-public GoodsCan be produced by market or government but have large spillover benefits.

Common Pool GoodsCommon Pool Goods

• Joint ownership• Fish in Lake Michigan• The UN plan to save

the Whales and Dolphin

• Gate Foundation to purchase from UN all whales and dolphins!

Public Goods & ServicesPublic Goods & Services

Note:Note:The Exclusion PrincipleDoes Not ApplyThe Exclusion PrincipleDoes Not Apply

Note:Note:The Exclusion PrincipleDoes Not ApplyThe Exclusion PrincipleDoes Not ApplySome Goods & ServicesWould Not Be ProducedBy The Market System

Public Goods & ServicesPublic Goods & Services

The Free Rider Problem:Visitors to Ozaukee County may use this public goodeven if they have never paid at tax in this county.

IndivisibleSubject to the free-rider problem

May Provide Large SpilloverBenefits

E. Stabilization of the EconomyE. Stabilization of the Economy

1. Should the Government take a Role?

2. Action is taken to deal with issues of unemployment and inflation.

STABILIZATION....whenSTABILIZATION....when

• Cut TaxesCut Taxes• Raise GovernmentRaise Government SpendingSpending• Run a DeficitRun a Deficit

ECONOMIC FUNCTIONS OF GOVERNMENTECONOMIC FUNCTIONS OF GOVERNMENTIn A RecessionIn A Recession

GDP: Growing to SlowlyOr High Unemployment

STABILIZATION....STABILIZATION....GDP: Growing too FastPrices Rising out of Control

• Raise TaxesRaise Taxes• Cut GovernmentCut Government SpendingSpending• Run a SurplusRun a Surplus

ECONOMIC FUNCTIONS OF GOVERNMENTECONOMIC FUNCTIONS OF GOVERNMENTIn A Period of InflationIn A Period of Inflation

BUSINESSESBUSINESSES HOUSEHOLDSHOUSEHOLDS

GOVERNMENTGOVERNMENT

NET TAXES FLOWTO GOVERNMENTFROM BUSINESSES

GOVERNMENTGOODS & SERVICES

FLOW TO BUSINESSES

NET TAXES FLOWTO GOVERNMENT

FROM HOUSEHOLDS

GOODS & SERVICESFLOW TO HOUSEHOLDS

FROM GOVERNMENT

EXPENDITURESFLOW TO

ACQUIRE RESOURCES

RESOURCESFLOW TO

GOVERNMENT

GOVERNMENTEXPENDITURES

FLOW TOPRODUCT MARKET

GOODS & SERVICESFLOW TO

GOVERNMENT

BUSINESSESBUSINESSESsubsidysubsidy

HOUSEHOLDSHOUSEHOLDSFICAFICA

Tax PaymentsTax PaymentsGOVERNMENTGOVERNMENT

The Federal Budget!The Federal Budget!

Total Revenues (Taxes) – Total Costs (Expenditures)

+ Budget Surplus0 Balanced Budget- Budget Deficit

2004 Deficit:$480 Billion

Sum of all yearly deficits is the National Debt of: 7.4 Trillion Dollars!

Projected 2005333 Billion

GOVERNMENT GROWTHGOVERNMENT GROWTHPurchases & Transfers...

•Government Purchases

GOVERNMENT GROWTHGOVERNMENT GROWTHPurchases & Transfers...

•Transfer Payments

•Government Purchases

The Federal BudgetThe Federal Budget

Federal Expenditures

How Does Government Spend Its Money????

Federal ExpendituresIncome Security 38%

Federal ExpendituresIncome Security 38%Health 20%

Federal ExpendituresIncome Security 38%Health 20%National Defense 18%

Federal ExpendituresIncome Security 38%Health 20%National Defense 18%Interest on Public Debt 15%

Federal ExpendituresIncome Security 38%Health 20%National Defense 18%Interest on Public Debt 15%All Other 9%

The Federal Budget Funded on a Percentage Basis of Income Tax Dollars

26.2% goes to the military22.6% goes to pay the interest on the national debt19.0% goes to health care 5.5% goes to income security 3.4% goes to benefits for veterans 3.2% goes to education 2.5% goes to nutrition spending 1.6% goes to housing 1.6% goes to the environment 0.4% goes to job training 14.0% goes to all other expenses

Remember…..FICA funds SocialSecurity Payments!

Of $10,000.00 Paid in Federal Income Tax: $2,620.00 goes to the military$2,260.00 goes to pay the interest on

the national debt$1,900.00 goes to health care $550.00 goes to income security $340.00 goes to benefits for veterans $320.00 goes to education $250.00 goes to nutrition spending $160.00 goes to housing $160.00 goes to the environment $40.00 goes to job training$1,400.00 goes to all other expenses

ExcludesFICA @7.5%

The Federal BudgetThe Federal BudgetFederal Receipts/Revenues

How Does Government Raise Its Money????

Personal Income Tax 45%

The Federal Budget, 1996The Federal Budget, 1996

Federal ReceiptsNotes:Notes:MARGINAL

TAXRATES

MARGINALTAX

Personal Income Tax 45%

The Federal Budget, 1996The Federal Budget, 1996

Federal ReceiptsNotes:Notes:Notes:Notes:MARGINALMARGINAL

TAXTAXRATESRATES

MARGINALMARGINALTAXTAX

RATESRATES

AVERAGETAX

Personal Income Tax 45%Payroll Taxes 35%

Personal Income Tax 45%Payroll Taxes 35%Corporate Income Tax 12%

Federal Receipts/Revenues

Personal Income Tax 45%Payroll Taxes 35%Corporate Income Tax 12%Excise or Sales Taxes 4%

Personal Income Tax 45%Payroll Taxes (FICA) 35%Corporate Income Tax 12%Excise or Sales Taxes 4%All Other 4%

STATE & LOCAL FINANCESTATE & LOCAL FINANCEState Expenditures

Public Welfare 32%

1994 DATA

Public Welfare 32%Education 21%

1994 DATA

State ExpendituresSTATE & LOCAL FINANCESTATE & LOCAL FINANCE

Public Welfare 32%Education 21%Health & Hospitals 10%

1994 DATA

Public Welfare 32%Education 21%Health & Hospitals 10%Highways 10%

1994 DATA

Public Welfare 32%Education 21%Health & Hospitals 10%Highways 10%Public Safety 8%

1994 DATA

Public Welfare 32%Education 21%Health & Hospitals 10%Highways 10%Public Safety 8%All Other 21%1994 DATA

State ReceiptsSales Taxes 49%

1994 DATA

STATE & LOCAL FINANCESTATE & LOCAL FINANCE

State ReceiptsSales Taxes 49%Income Taxes

(Personal & Corporate) 32%

1994 DATA

(Personal & Corporate) 32%Corporate Income Tax 7%

1994 DATA

(Personal & Corporate) 32%Corporate Income Tax 7%Property Taxes 2%

1994 DATA

(Personal & Corporate) 32%Corporate Income Tax 7%Property Taxes 2%Death & Gift Taxes 1%

1994 DATA

(Personal & Corporate) 32%Corporate Income Tax 7%Property Taxes 2%Death & Gift Taxes 1%Licenses Other Taxes 9%

1994 DATA

Local Expenditures

1994 DATA

Education 42%

Local Expenditures

1994 DATA

Education 42%Welfare, Health, & Hospitals 14%

Local Expenditures

1994 DATA

Education 42%Welfare, Health, & Hospitals 14%Housing & Sewerage 8%

Local Expenditures

1994 DATA

Education 42%Welfare, Health, & Hospitals 14%Housing & Sewerage 8%Public Safety 10%

Local Expenditures

1994 DATA

Education 42%Welfare, Health, & Hospitals 14%Housing & Sewerage 8%Public Safety 10%Highways 5%

Local ExpendituresEducation 42%Welfare, Health, & Hospitals 14%Housing & Sewerage 8%Public Safety 10%Highways 5%All Others 21%

1994 DATA

Local ReceiptsProperty Taxes 75%

1994 DATA

Local Receipts

1994 DATA

Property Taxes 75%Sales & Excises 15%

Local Receipts

1994 DATA

Property Taxes 75%Sales & Excises 15%Personal & Corporate

Income Taxes 6%

Local ReceiptsProperty Taxes 75%Sales & Excises 15%Personal & Corporate

Income Taxes 6%All Other 4%

1994 DATA

Local Receipts

LOTTERIESLOTTERIES

1994 DATA

Local Receipts

Fiscal FederalismFiscal Federalism

LOTTERIESLOTTERIES

1994 DATA

LOTTERIESLOTTERIES

Local Receipts

1994 DATA

Fiscal FederalismFiscal Federalism

ANY QUESTIONS?

functional distribution of functional distribution of incomeincome

personal distribution of personal distribution of incomeincome

durable gooddurable good

non-durable goodnon-durable good

servicesservices

plantplant

firmfirm

vertical combinationvertical combination

horizontal combinationhorizontal combination

conglomerate conglomerate combinationcombination

industryindustry

sole proprietorshipsole proprietorship

partnershippartnership

corporationscorporations

stocksstocks

bondsbonds

limited liabilitylimited liability

double taxationdouble taxation

principal-agent problemprincipal-agent problemCopyright McGraw-Hill, Inc. 1999

monopolymonopoly

spillover costsspillover costs

spillover benefitsspillover benefits

exclusion principleexclusion principle

public goodspublic goods

free-rider problemfree-rider problem

quasipublic goodsquasipublic goods

government government purchasespurchases

transfer paymentstransfer payments

personal income taxpersonal income tax

marginal tax ratemarginal tax rate

average tax rateaverage tax rate

payroll taxespayroll taxes

corporate income corporate income taxtax

sales & excise taxessales & excise taxes

property taxproperty tax

fiscal federalismfiscal federalism

lotterieslotteriesCopyright McGraw-Hill, Inc. 1999

Next:Next:

The United StatesThe United Statesin thein the

Global EconomyGlobal Economy

Chapter 6Chapter 6

Up Coming Stuff Quiz Chapter 5 Friday, 10/14 Bonus Work Chapter 5 Monday, 10/17 All homework Chapters 4 & 5 Tuesday, 10/18 Review Wednesday, 10/19 Test.

capitalist income

proprietors income profits

total income

inequitable income

corporation income profits

corporate profits

roles of government

measures wages

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