THE U.S. ECONOMY

1
THE U.S. ECONOMY
2
Preview

• The private sector
• product markets
• competitive industries
• imperfect competition
• factor markets
• labor
• capital

3

• The public sector
• size and roles
• stabilization
• monetary policy
• fiscal policy
• redistribution
• allocation
• externalities
• public goods
• monopoly
• taxation

4
The Private Sector

• Perfect competition versus monopoly
• monopoly a source of market failure
• How monopolized are U.S. product markets?
• Concentration ratios
• percent of total domestic output of largest 2, 4,
  8,, n firms
• little change over whole century
• Increased competition from global market
• consider auto industry

5
Industry Structure and Efficiency

• Under perfect competition, in equilibrium price
  equals marginal cost
• Thus, marginal benefit of consumption equals
  marginal cost of production (net benefit
  maximized)
• Under monopoly, price exceeds marginal cost
• Thus, society would get added net benefit
  producing more

6
Perfect Competition


MC
S
Pe MCe
Pe
d, MR
D
0
q
0
qe
Q
Qe
7
Monopoly

MC
Pe
Deadweight loss
MCe
D
Q
0
Qe
MR
8
Monopoly Welfare Loss

• Very small
• one study estimates a less than 1 gain in output
  if all monopoly power eliminated
• additional loss from rent seeking, i.e.,
  resources used up to erect barriers
• The bottom line
• the U.S. product market highly competitive
• the U.S. product market highly efficient

9
The Labor Market

• Market allocation with influence from unions,
  government, and discrimination
• The impact of unions
• less than 15 unionized
• weak compared to Europe
• European unions politicized
• effects on productivity
• negative
• strikes
• featherbedding and work rules
• positive
• training
• reduced turnover and higher moral

10

• effect on wages
• unions increase unionized wages about 15 to 18
• increased wages cause reduction in quantity of
  labor demanded in unionized sector
• thus supply of labor in non-unionized sector
  increased
• thus non-unionized wages depressed
• so overall effect on wages a wash

11
Union
Non-Union


Perceived Supply w/ union wage floor
S
S'
S
Wuf
Supply w/o union wage floor
Wn1
Wue
Wn2
D
D
Lue
Luf
Ln1
Ln2
Labor
Labor
12
The Labor Market

• The impact of government
• licensing
• public education and job training
• anti-discrimination regulations
• affirmative action
• hiring quotas
• minimum wages
• minimum wages cause unemployment

13
The Effect of Minimum Wages

I -- Better off (working at higher wage
than before) II -- Worse off (were working,
now unemployed) III -- Frustrated (would
like to work at higher wage but
cant find work -- counted as
unemployed)
Excess supply
Wm
We
0
Le
Ls
Lm
Labor
I
II
III
14
Discrimination

• Women
• Minorities
• Potential effects
• exclusion from certain occupations/channeling
  into certain occupations
• reducing wages of women and minorities
• Most work indicates that discrimination does
  exist but affect on wages small

15
Capital Markets

• Brings together users and suppliers of credit
• Financial intermediaries and the efficiency of
  the capital markets
• Very well organized and efficient
• stock markets
• bond markets

16
The Public Sector

• Small relative to other industrialized countries
• Especially small given large defense needs
• Government expenditure about 35 of GDP
• 24 federal
• 11 state

17
Government Expenditures
18
(No Transcript)
19
(No Transcript)
20
The Roles of Government

• One national government
• Fifty state governments plus D.C. and territories
• About 3,000 county governments
• Thousands of municipal governments
• Thousands of special districts
• school districts, water districts, fire districts

21

• Stabilization
• A national level activity
• state and local governments would not be able to
  conduct effective stabilization
• U.S. unusual in the complete absence of any real
  economic planning to guide stabilization
• monetary policy conducted by the Federal Reserve
• independence of the Fed
• fiscal policy conducted by a changing mixture of
  executive and legislative bodies
• highly politicized and ineffective in most
  instances

22

• Redistribution
• Should be a national level activity
• local governments get into trouble when they try
  to redistribute
• New York City
• Redistribution to poor through the tax system
• the federal personal income tax is progressive
• progressive taxes take a higher share from the
  rich
• other taxes are either proportional or regressive
• regressive taxes take proportionately more from
  the poor
• social security tax
• sales taxes
• sin taxes
• overall tax structure proportional
• thus no redistributive effect

23

• Redistribution through transfers
• cash transfer
• Temporary Assistance to Needy Families
• in-kind transfers
• food stamps
• Medicaid
• housing subsidies
• Redistributive effect of public (free) provision
  of private goods
• public education
• Putting all these effects together makes real
  distribution much more equal than when only money
  incomes counted
• Slow trend toward equality until late-sixties
• Some reversal since late-sixties

24

• Allocation
• mix of federal, state, and local responsibilities
• correcting market failure
• externalities
• public goods
• merit/demerit goods
• monopoly

25
Externality

• Cost or benefit not accounted for by decision
  maker
• e.g., pollution
• Externalities can be negative (costs) or positive
  (benefits)
• They can be the result of production or
  consumption
• Usually a result of conflict in use of a resource
  because of inability to define/enforce property
  rights

26
Negative Externality
Assume an external cost of E per unit output

Marginal Social Cost
Market Supply
E
B
A
Welfare loss triangle
C
Market Demand, Marginal Social Benefit
0
Qmarket
Qeff
Q
27
Correcting Externalities

• The possibilities
• corrective taxes
• a tax of E per unit will correct the
  misallocation
• hard to know how much to tax
• not much use of corrective taxes in U.S.
• gasoline tax a crude corrective tax
• regulations and standards
• requirements to use stack scrubbers or other
  pollution control devises
• pollution limits
• violators fined
• regulations and standards commonly used in U.S.
• generally inefficient approach

28

• markets for pollution rights
• define air quality standard for each area
• define rights to pollute up to this limit
• distribute rights to polluters
• allow trading of rights
• much more efficient
• those polluters able to reduce easily will sell
  their rights to those for whom reduction is more
  costly
• the result is a bigger bang for the buck
• in use and being developed in U.S. under the
  Clean Air Act
• being proposed for the international treaty on
  greenhouse gas reductions

29
Public Goods

• Characteristics
• non-excludable
• no feasible way to keep anyone from consuming the
  good
• no one would be able to charge a price since no
  one would have to pay it to consume the good
• non-rival
• ones consumption does not alter the availability
  of the good for others to consume
• zero cost to provide good to an additional
  consumer
• efficient price is zero, so no one would provide
  it

30

• Examples
• national public good
• national defense
• everyone consumes it no matter what
• consumption same no matter where they are
• local public good
• police protection
• consumption varies with distance
• local public good

31
Private Good
Public Good


MSC
Consumers pay market price and consume quantity
which maximizes utility given price. Thus, each
consumes different quantity at same price.
Market demand is sum of quantities at each
possible price.
3Pi
Every person consumes all that is produced. That
is, everyone consumes same quantity.
Efficient output where sum of each
consumers marginal benefit equals marginal
social cost.
MSC
PC
Peff
PB
3Di
PA
3Di
DB
DC
DA
DB
DC
DA
0
0
Q
Q
Qeff
Qeff
QB
QA
QC
32
Fiscal Federalism

• Federal government provides national public goods
• since national defense is consumed by all no
  matter where they are, it would not make sense
  for a state to provide it
• Local governments provide local public goods
• Morgantown provides own police protection
• Ideally, those who benefit should pay

33
Monopoly

• Anti-trust to prevent collusion
• Regulation to control natural monopolies
• natural monopolies are characterized by
  decreasing average costs
• to break up a natural monopoly does no one a
  favor
• regulating firm to act like a perfectly
  competitive firm generates a loss
• average cost pricing
• a variant reasonable rate of return pricing
• gives firm incentive to inflate costs

34
Natural Monopoly

Monopoly profit without regulation
Pm
Loss under competitive (P MC) pricing
ACm
Pr ACr
AC
ACc
MC
Pc
D
0
Qm
Qc
Q
MR
35
Paying For All This -- Taxation

• Payroll and income tax comprise 80 of federal
  receipts
• income tax is progressive
• burden on rich more than poor
• payroll tax is regressive
• burden on poor more than rich
• Sales and property taxes comprise 45 of state
  receipts
• Federal grants are another 21
• sales taxes are regressive
• property taxes are more or less proportional
• Overall U.S. tax structure is more or less
  proportional

36
Federal Taxes
37
State Taxes