Chapter
4 Economic Decision-Makers: Households, Firms, Governments, and the Rest of the
World
Economics: The study of how people
use their scarce resources to satisfy their unlimited wants.
Macroeconomics: Study how
decisions of individuals coordinated by markets in the entire economy join
together to determine economy-wide aggregates like employment and growth. They
study the performance of the economy as a whole.
Market: Means by which
individuals interact to buy or to sell; mechanism that coordinates the
independent intentions of buyers and sellers.
Before we can go on, it is important to
understand what economic actors are interacting in these markets and their
relationships to one another.
Four (broadly defined) economic actors are:
1. Households
2. Firms
3. Governments
4. "The Rest of the World"
I. Households
All those people living under one roof are
considered a household.
Households do two fundamental things vital to
the economy.
1. Demand
goods and services from product markets
2. Supply
labor, capital, land, and entrepreneurial ability to resource markets.
Economists think of each household acting as a
single decision-maker.
Householder: The key
decision-maker in the household.
A. Evolution
of a Households
Households have changed considerably in economic
history.
Earliest households were totally self-sufficient.
They made what they consumed and consumed what they produced to a large extend.
Specialization took place within the household.
Are households self-sufficient today? How are
they different?
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Very few people produce their own food. With the
increase in agricultural productivity, fewer people are needed to produce the
food to feed a nation.
-
People work away from the home.
How have households changed since the 1950s?
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Women working: 1950 15% of married women with
children under 18 were in the labor force. Today more than 1/2 married women
with young children are in the labor force.
-
Higher education among women, growing demand for
labor, increased the opportunity cost of staying at home. Opportunity
cost-define.
-
Two-earner households- less production occurs at
home, more goods and services demanded from the market.
B. Households
are rational utility maximizers.
Economists assume that individuals, and thus
households, attempt to maximize their utility.
UTILITY: The satisfaction
received from consumption; the sense of well being. Utility is subjective (not
objective). One household may have different goals than another.
Rational: They act in their
own best interest (in the interest of their own goals- maximizing their
utility), would not make choices that would make them worse off.
C. Households
as Demanders
Personal income is allocated among three uses:
1. savings
2. consumption
3. taxes
In US: 80% consumption, 5% savings, and 15%
taxes
Consumption:
1. Durable goods: designed to last three
years or more. 13%
2. Nondurable goods: food, clothing, and
gasoline 30%
3. Services: childcare, medical care 57%
D. Resource
suppliers
Households use their limited resources (labor,
capital, land, and entrepreneurial ability) to maximize their own utility.
They can use these resources at home, or they
can sell these resources in the resource market to earn money to spend in the
product market.
You can see that a majority of personal income
in the US is from labor earnings, rather than from ownership of other resources
such as capital or land. (Exhibit 1, page 72)
Proprietors:
People who work for themselves rather than for employers (plumbers, farmers,
and doctors)
Transfer payments:
Cash (welfare benefits, unemployment, disability) or in-kind benefits (food
stamps - for specific goods/services) given to individuals as outright grants
from the government.
***Some households have few resources valued in
the market. In those cases, the government provides temporary public
assistance.
II. Firms
Firms: Economic units, formed
by profit-seeking entrepreneurs who employ resources to produce goods and
services for sale.
A. Firms
have evolved as providers of goods and service.
-
Prior to the 18th century, Britain had a cottage
industry system. Firms supplied raw materials (lumber, wool) to households that
turned raw materials into finished goods.
-
This system still exists in some parts of the
world.
-
With the expansion of the economy-more demand
for final goods and services-entrepreneurs organized various stages of
production under one roof.
-
Work was
organized in factories which 1. Promoted more efficient division of labor 2.
Allowed for direct supervision of laborers 3. Reduced transportation costs 4.
Facilitated use of machines.
-
Around 1750 (start of industrial revolution) the
development of large-scale factory production spread to Europe, North America,
and Australia.
B. Kinds
of Firms
1. Sole Proprietorships: A firm with a
single owner who has the right to all profits and who bears unlimited liability
for the firm's debts. (plumber, doctor)
-
Must raise all the money to start business, is
solely responsible for all debts.
-
Account for 73% of all US businesses (6% of all
US business sales)
2. Partnerships: A firm with multiple
owners who share the firm's profits and each of who bears unlimited liability
for the firm's debts.
-
Two or more people agree to contribute resources
in return for a share of the profit or loss. (law, accounting, medical
partnerships)
-
Account for 7% of all firms (5% of all US
business sales)
3. Corporations: A legal entity owned by
stockholders whose liability is limited to the value of their stock.
-
Owners issued stocks that entitle them to
profits in proportion to their stock ownership.
-
Many individuals pool money (1000s even
millions)
-
Easy to amass large funds, limited liability
-
stockholder has little influence over corporate
policy
-
corporate income taxed twice
C. Household
production still exists.
Name some forms of household production that
still exist.
- Cooking, cleaning
- Fixing own cars
- Paint own home
Why?
If a householder's opportunity cost of
performing a task is below the market price of the task, then the householder
usually performs that task.
Opportunity cost:
the value of the next best alternative.
Example:
1. Consider
my decision to mow the lawn or pay someone else to do it.
What is my next best alternative to mowing the
lawn? I would probably watch read, watch TV or play game; value to me $10.
Preparing an extra hour isn't my next best alternative, because I'm well enough
prepared, and I won't get any extra salary from over-preparing. Opportunity
cost = ~$10
Suppose the market price of getting someone to
mow my lawn $25. What would I do?
2. What
about a Dr. making the same decision. His next best alternative is working an
extra hour. He makes about $100 after taxes. Working is hard -$20. Opportunity cost = ~$80.
Suppose the market price of getting someone to
mow his lawn $25. What would the doctor do?
Some Reasons for household production:
1. No
skills or specialized resources are required
2. Household
production avoids taxes
3. Household
production reduces transaction costs: Transaction costs-the costs of
time and information required to carry out market exchange.
4. Household
production allows for more control over the final product.
5. Technological
Advances Increase Household Productivity
III. The Government
A. MARKET
FAILURE: A condition that arises when unrestrained
operation of markets yields socially undesirable results.
In the case of market
failure, intervention could improve society's overall welfare.
B. The
Role of the Government
1. Establishing and Enforcing the Rules of the
Game.
2. Promoting Competition
3. Regulating Natural Monopolies
4. Producing public goods.
Public good: A good that,
once produced, is available for everyone to consume, regardless of who pays and
who doesn't.
5. Externality: A cost or benefit that
falls on third parties and is therefore ignored by the two parties to the
market transaction.
6. Income Distribution
7. Full employment, Price stability, Economic
Growth
C. Government
is a unique Problem for Economists
1. What is the goal of government?
-
Households maximize utility
-
Firms maximize profits
-
It might be said that government officials
maximize the number of votes they will get in the next election.
2. Voluntary exchange vs. Coercion
Market is based on voluntary exchange.
Unless there is 100% agreement--government
decisions involve some degree of coercion
3. No Market Prices
Selling price of public output is often zero or
well below the cost of production.
In government budget/expenditure does not
directly link cost/benefit of a public program.
D. Size
of Government
- If we measure government spending as % of GDP
(total value of all goods/services produced in US.)
Prior to 1926 never exceeded 3%
1929 (year Great Depression began) 10%
Depression, WWII-- Change in Macroeconomic
thought.
By 1998 32% of GDP
Compared to:
Japan 36%
U.K 39%
Canada 42%
Germany 47%
Italy 50%
France 54%
E. Government
Revenue
Taxes: provide bulk of
revenue. (Exhibit 3, page 81)
Tax Principles: principles on
which tax often justified.
1. Ability to pay: Those with a greater
ability to pay should pay more. (income tax)
2. Benefits-received: Those who receive
more benefits from government program funded by tax should pay more. (tax on
gasoline funds highway construction)
Tax Incidence: The
distribution of tax burden among taxpayers. (Indicates who bears the tax
burden.)
Marginal tax rate:
percentage of each additional dollar that goes to taxes.
Kinds of Taxes:
1. Proportional tax (flat-rate tax): The
tax as a % of income remains constant as income increases.
2. Progressive tax: the tax as a % of
income increases as income increases.
3. Regressive tax - the tax as a % of
income decreases as income increases.
IV. The rest of the World: Households, firms,
and governments in over 200 countries around the world.
Circular Flow Model