· Goods are tangible items of value.
· Services are intangible things that have value.
· Consumers are people who buy goods and services for personal use.
· Consumption is the act of buying goods and services.
· Factors of production are the ingredients that go into the production of goods and services.
· Economics is the study of how people and societies use limited resources to satisfy their needs.
· Standard of Living refers to the quantity and quality of goods and services.
· Economists are professionals who study the ways in which society allocates its resources to satisfy its wants.
Traditional economic system is usually characterized by a
self-contained community. These systems are usually found in rural areas of
· Command economy is governed by a central authority, usually the government. The government decides what and how things will be produced according to the governmental needs. They also decide who will receive the goods.
· Market economy is a system in which all decisions are made by individuals and business with regards to production and distribution.
· Microeconomics is the study of the effects of economic forces upon individual parts of the economy.
· Macroeconomics is the study of impact of changes on the economy as a whole.
· Economic model is a simplified way of looking at an economic problem. This may be expressed in the form of a statement, graph or mathematical formula.
· Ceteris Paribus means "All other things being equal."
Fundamental Questions of Economics
· What goods and services should be produced?
· How should they be produced?
· Who will receive the good and services that are produced?
Factors of production:
1. Human Resources (Labor)
Human Resources, labor and workforce are all terms that describe the people who produce goods and services. Human resources influence the production of good and services, in that if a country is lacking in workforce, or workers, then that may limit the production of goods and services. It is also determined by labor productivity. Labor productivity is defined as the amount of labor a worker produces in a specified amount of time. The worker's labor productivity is determined by:
· The skill of the labor force.
· The quality and quantity of the tools available.
1. Natural Resources (Land)
Natural resources are materials obtained from the land, sea and air. These materials may be renewable or nonrenewable. Renewable resources include plants and animals, while nonrenewable resources include mineral ores and fuels.
2. Capital Resources (Capital)
Capital resources are the machines, tools and buildings that are used to produce goods and services. In economic terms, Capital is divided up into liquid assets (money) and physical assets (capital goods). Capital is eventually used up or worn out, and its value declines. This devaluation is called, in economics, depreciation.
The formation of new capital goods is called capital formation, which is an essential economic process in all societies, to replace the capital that is used up or worn out. New capital resources or goods must be produced or one loses production capabilities. Capital formation takes place when individuals and businesses set aside a portion of their income as savings for the future.
3. Entrepreneurship (Management)
Entrepreneurship is the process of bringing together the three factors of production (natural resources, labor and capital), and creating a business.
When deciding which goods and services to produce, one must often make a trade off, in which ones needs to give up one thing in order to obtain something else. Economists refer to this tradeoff as the opportunity cost of the choice.
When deciding how they should be produced, management decides how to combine the factors of production most efficiently (deciding whether to use more human labor, or more machine labor, etc.) The effect of how the goods are produced usually affects society in general, by causing pollution, or destroying forests, etc.
Human wants are always greater than the resources needed to satisfy them.
Economics is the study of scarcity and choice; unlimited resources vs. unlimited want.
The industrial revolution began, in
· Labor was provided by the Enclosure Acts which enabled the nobles to charge to farm land that was until that point in time public land. As a result of being unable to pay the new taxes to the lords, many fled to the cities.
· Land came from these same Enclosure Acts.
· Capital came from profits made from trade. England had a flourishing trade with its colonies.
· Management came from the middle class. It was considered low class for nobles and other upper class to "dirty" their hands in business.
How did this differ from America's industrial revolution?
In America, the industrial revolution began after the Civil War. In America, there was an "aristocracy of money," and the way to become high-class was to make money. Where did the factors of production come from?
· Labor was provided by the mass immigration in the 1870s (NOT FROM SLAVERY, despite being right after the Civil War).
· Land was available for the taking.
· Capital came from profits made during the Civil War.
· Management came from the educated poor, and the middle class. America was very socially mobile because if you were smart, worked hard, and made money, you could make yourself upper class. Also, there was unlimited opportunity because education in America was free, as it is now.
Adam Smith had the theory of Economic Darwinism. He believed that only strong businesses will survive, and that government shouldn't interfere.
· Capitalism is the economic system of the United States. In this system, the means of production and the questions of WHAT, HOW and WHO are answered by the market rather than by tradition or an economic plan. This is also known as free enterprise, and although the government may require some supervision and regulation by the government, businesses have a lot of freedom. One notable exception to this rule is public utilities, which usually have a monopoly (sole control over an industry or product), and are thus closely regulated by the government.
· Free enterprise see Capitalism.
· Right to private property allows individuals to own property and use it in any lawful manner that they choose. However, the government may tax property holders, and may seize property under the right of eminent domain (the government may seize any property it intends to use for a public purpose as long as it fairly recompenses the owner).
· Profit motive is the desire of an entrepreneur to make a profit. This motivates business firms and individuals to try hard to keep costs down and increase their income from sales.
· Consumer sovereignty says that the customer dictates what will be manufactured and what won't, by choosing to buy it or not.
· Competition pressures business firms to constantly try to provide the best services and to create the best products at the lowest possible prices.
· Specialization is when a business specializes in providing one service, or producing one form of goods. Companies that produce only a few products or are able to concentrate on developing new machines and techniques that will increase production, improve quality and lower costs for these products
· Gross National Product (GNP) is the total value of all goods and services produced annually by one nation. The formula for calculating the gross national product is: C (consumer spending) + G (Government spending) + I (business spending [investment]) = GDP.
Circular Flow of Economic Activity
· Circular Flow of Money explains that no matter how money is earned, it returns to the economy when buyers purchase the things they need or want.
· Circular Flow of Goods and Services describes how there is also a circular flow of goods and services. The consumers (public) purchase the goods and services produced by business. In turn, the consumers sell their productive services to business (by working at a job).
· Circular Flow of Money, Goods, and Services between the Government and the Public In this graph, the government's productive services are transportation, sales taxes, and tolls. Taxes, in this graph are self-explanatory. Wages, Interest, Etc. represents wages, welfare, interest and others that the government pays the public. Goods and services are the services that the government supplies for the public.
· Circular Flow of Money, Goods, and Services between the Government and Businesses. In this graph, productive services represent when a business does a job (contracting, etc.), or provides goods or products for the government. Goods and services are when the business uses a government service, such as the postal service, to send and receive mail.
· Demand is the desire to purchase a particular item at a specified price and time, accompanied by the ability and willingness to pay.
· Demand Schedule means that the quantity demanded of an item varies with the price of an item.
· Demand Curves show how much of a commodity will be sold at any given price.
· The Law of Demand says that as the price of an item decreases, the quantity demanded will increase. Conversely, as the price increases, the quantity demanded will decrease.
· Marginal Utility is the degree of satisfaction or usefulness a consumer gets from each additional purchase of a product or service.
· Principle of Diminishing Marginal Utility states that each additional purchase of a product or service by a given consumer will be less satisfying than the previous purchase.
· Elasticity of Demand describes the percentage change in demand that follows a price change. The more demand expands or contracts after a price change, the greater the elasticity of the demand. The demand for most goods and services may be described as either relatively elastic or relatively inelastic.
What makes demand elastic or inelastic? If one of the following conditions is present, the demand for a good or service will usually be sensitive to price changes.
2. The item is considered a luxury.
3. The price represents a large portion of the family income.
4. Other products can easily be substituted for it.
5. The items are durable.
What is the significance of Demand Elasticity?
When raising prices, one must take into consideration whether the goods or services offered are elastic, or not. If the product is elastic, by raising prices, one could end up losing money through lack of patronage.
· Increase/Decrease in Demand is determined by the quantity of goods purchased at one price. If more goods are purchased at the same price, it is considered an increase in demand, and vice versa.
· Sole proprietorship is a business that is owned by one person.
Advantages of Sole Proprietorship
6. Easy to form
7. "You’re the Boss"
8. Potential Profit
9. Singly Taxed
Disadvantages of Sole Proprietorship
4. Unlimited liability
5. Limited Capital
6. Limited Life
7. All power, but all responsibility
· Partnership is a business organization owned by two or more persons, who are known as "partners."
Advantages of Partnership
1. Additional Capital
2. "Two heads are better than one"
3. Easy to Organize
4. Singly Taxed
Disadvantages of Partnership
1. Limited Life
2. Partners May Disagree
3. Difficult to Sell
4. Limited Capital
5. Unlimited Liability
6. Split Profits
· Corporation is a business organization licensed to operate by a state or the federal government.
Advantages of Corporation
1. Limited Liability
2. Unlimited Life
3. Ease of Transfer
Disadvantages of Partnership
1. Difficulty and Expense of Organizing
2. Double Taxation- One of the reasons that people invest in a corporation is to receive dividends, profits that are distributed to shareholders. These dividends are subject to personal income taxes.
3. Less Power
How Large Corporations Are Organized.
Since corporations have many different stockholders, or partial owners, and it would be impossible for all of them to be involved in running the business, those owners elect a board of directors to run the business. The board of directors sets long-range goals for the corporation but leaves day-to-day operations to the officers. The board of directors selects officers to do the actual running of the business.
· Government-Owned Corporations such as the U.S. Postal Service, or the MTA were developed because private interests were either unable or unwilling to supply needed services.
· Privatization is the process of transformation of publicly run businesses into privately operated and owned ones.
· Not-for-Profit Corporations such as the United Way and the Red Cross are exempt from income taxes, since they put their profits back into the company to further their work.
· Cooperatives are associations of individuals or organizations.
· Consumer Cooperatives is a retail business owned by some or all of its customers.
· Producer cooperatives are organizations of producers who cooperate in buying supplies and equipment and in marketing their products.
· Cooperative apartment buildings are run by corporations whose capital stock is owned by its tenants.
· Charter is the corporation’s license. It gives the firm the right to do business.
· Shareholders or Stockholders are people who own shares of stock.
· Shares of Stock are certificates representing ownership in a corporation.
· Subchapter S of the Internal Revenue Code allows the owners of corporations with 75 or fewer stockholders to be taxed as though they were sole proprietorships or partnerships, enjoying limited liability and avoiding double taxation.
· Initial Public Offering (IPO) is the initial offering of a corporations private stock to the public.
· Stock Exchanges are places where shares in the nation's major corporations are bought and sold.
· Equity financing is another name for the corporation's selling of stock to make or raise money.
· Bonds are certificates issued in exchange for a loan.
· Common stocks entitle their owners to a voice in the selection of the board of directors, and may also share in the profits of the company whenever the corporation's board of directors decides to pay dividends.
· Preferred Stock owners have no voting rights; however, they are entitled to a fixed dividend whenever the board of directors votes to pay it.
· Corporate Bonds are promises by a corporation to repay a specified sum (the face value of the loan, or principal) at the end of a specific number of years. If a company declares bankruptcy, the company will pay off its bondholders first.
· Government Bonds are promises by the government to pay back a specified sum (principal) plus interest on a specified date.
· Investment Bank is a bank that specializes in this kind of activity. The investment bank underwrites the issue: it buys the entire issue of some corporation's stocks or bonds, and then sells the securities to the public at a profit.
· Over-the-Counter Market consists of the many brokerage firms throughout the nation that buy "unlisted" stocks and sell them to investors.
· Brokerage Firms are companies of sale specialists known as brokers.
· Brokers buy and sell securities on behalf on their clients and receive a commission for their work. They act as intermediaries between the buyers and the sellers, and receive fees and/or commissions from each transaction.
· Securities are stocks and bonds.
· Dividends are a part of the company's profits.
· Capital Growth is an increase in value of a stock from the time of purchase.
· Speculators (investors) hope to make a quick profit by correctly predicting price movements.
· Buying Long is the term given for investors who believe the price of their stock will rise from the time of purchase. They will then sell it for a higher price.
· Selling Short is the term given to investors who are expecting the price of a specific stock to decline. In such circumstances, they normally would sell any of this stock in hopes of buying it back later at a less expensive price. To sell short is to sell stock that you do not own (that you borrow from a broker) in the hope of buying the stock back later at a lower price.
· Buying on Margin is the act of purchasing stocks on credit.
· Margin is the percentage that a buyer has to put up in cash in order to buy the stock on credit.
· Junk Bonds are highly risky investments that offer extremely high rates of interest.
· Portfolios are groups of investments that an investor might own.
· Specialized markets are markets that exist for selling and buying commodities.
· Securities and Exchange Commission (SEC) was created by an act of Congress in 1934. Its purpose is to protect the public against deception or fraud in the selling of securities.
· Caveat Emptor means, "let the buyer beware."
· Public Corporations are corporations whose stock is bought and sold by the public.
· Prospectus describes the operations of a company that is issuing new securities.
· Annual Report provides financial information about a company whose securities are traded on an exchange.
· Balance Sheet is a snapshot of the financial affairs of a business at a particular time.
· Assets represent anything of value that is owned by a business.
· Liabilities represent the obligations, or debts, of a company.
· Net Worth (Owner's Equity) is the difference between what a firm owns and what it owes.
· Transpose is an accounting term meaning, "to transfer."
· Income Statement is the summary of financial activities of a firm over a period of time.
Chapter 7 (Assignment 8)
Monopsony is a market in which there is only a single buyer, usually the government.
Monopoly is firm that controls the entire supply of a good or service. In this market:
10. There is a single supplier. This supplier, since he is the only one selling the product, controls how much of the product is being sold (supply) and how much that product costs (price).
11. There are no close substitutes for the product that is being sold.
12. It would be extremely difficult for any other firm to enter the industry, for one of the following reasons:
· High Costs make it extremely difficult to enter the business.
· Exclusive Ownership of a Resource also makes it difficult to enter the business; if you don't own it, you can't sell it.
· Legal Barriers such as patents, copyrights, and public franchises. (See terms)
Oligopoly is a market in which a few sellers produce all or most of the supply of a product. Some economists define oligopoly as an industry with a concentration ratio of 50% or more (See Concentration Ratio). Carbonated soda, car manufacturers and breakfast cereals are three such examples. In oligopolies, if one manufacturer cuts prices, all manufacturers are forced to cut prices, because products are essentially identical. Therefore, oligopolies try to avoid price competition and rely on the following factors to sell their product.
8. Product Differentiation refers to whatever it is that gives buyers the impression that virtually identical products are different. Brand names, advertising campaigns, packaging, and the quality of services are the kinds of things that make one product more attractive to buyers than another virtually identical product.
9. Collusion refers to the fact that since there are so few competing firms in an obligopolistic market, there is a great temptation to limit competition by setting prices and dividing the market among these few firms. This is known as collusion, and is illegal.
10. Price Leadership is an alternative to collusion, and is similarly illegal. This is the practice of having the most powerful company set its price, and having the other companies follow suit.
Conditions of Pure Competition
5. There are many buyers and sellers acting independently. No single buyer or seller is big enough to affect the market price.
6. Competing products offered for sales are virtually identical, so buyers do not care from whom they buy the product.
7. Buyers and sellers are fully informed about prices, quality, and sources of supply.
8. Firms can enter and leave the market at will.
Conditions of Monopolistic Competition
7. Product differentiation
8. Many sellers who produce similar products that the buyer believes differ in some qualities.
· Market Power refers to the power of buyers and sellers to influence prices. In a perfectly competitive market such as the egg market, there are so many buyers and sellers that no one buyer or seller has the power to set the prices.
· Imperfect Competition describes markets where there is neither pure competition nor pure monopoly.
· Patents give the inventor of new products the exclusive right to market their inventions for a limited time period.
· Copyrights give similar rights to authors, musicians, and artists. The federal government grants patents and copyrights as ways of rewarding innovation, cultural achievements, and scientific progress.
· Public Franchises are licenses granted by governments to do business within their jurisdictions. Examples include public utilities, cable television, etc.
· Monopoly Power refers to the ability of a group of firms to behave as if it were one big monopoly.
· Concentration Ratio is the percentage of an industry's total output produced by its four largest firms.
· Price takers are sellers who will take whatever price they can get for their goods.
Chapter 7 (Assignment 9)
· Trust is a large business monopoly whose shareholders place control of the firm in the hands of trustees. Trusts use underhanded or illegal means to gain advantages that enabled it to undersell (sell for lower prices) all of its competitors. Sherman Antitrust Act and Clayton Act outlawed trusts that were "in restraint of trade."
· Interstate Commerce Act (1887) restricted monopoly power of the railroads by creating the nation's first regulatory agency, the Interstate Commerce Commission.
· Sherman Antitrust Act (1890) declared that "...every contract, combination... or conspiracy in restraint of trade is illegal." It was weak because:
4. It failed to specify exactly what constituted a "restraint of trade."
5. It failed to create an agency responsible for administering the law.
6. The United States Supreme Court in 1903 held that only "unreasonable" trade restraints were illegal and the law could be used to curb the power of labor unions.
· Clayton Antitrust and Federal Trade Commission Acts (1914) attempted to correct the weaknesses of the Sherman Act by:
4. Describing specific practices as "restraints of trade."
5. Exempting labor unions from the provisions of the antitrust laws.
6. Creating a regulatory agency, the Federal Trade Commission.
· Robinson-Patman Act (1936) sought to protect small stores from unfair competition by chain stores and other large retailers. Wholesalers became required to offer the same discounts to both large and small retailers, unless the discounts could be justified by lower costs.
· Celler-Kefauver Antimerger Act (1950) prohibited mergers that would result in the creation of a monopoly.
Why are Monopolies considered bad?
1. Monopolies raise prices because fewer goods are available and there is competition for the ones available.
2. Monopolies Reduce Output and Living Standards because fewer goods are available.
3. Monopolies are Inefficient because they don't have to worry about competition.
4. Monopolies are insensitive to Consumer Demand because they are the only suppliers, there is no alternative.
5. Monopolies Threaten Our Political System because they spend millions of dollars to get favorable laws passed.
Why are Monopolies not necessarily bad?
1. Economies of Scale; mergers often result in reduced costs, increased productivity and technological innovation; therefore it raises the standard of living and the consumer benefits in terms of new and improved products at lower costs.
2. International Competition; In all other countries, companies are allowed to have companies that violate antitrust laws; International Companies thrive without antitrust laws, while American companies often have trouble competing.
3. Antitrust Work is impractical; Many of the antitrust cases prosecuted by the United States government cost too much, take too long and should not have been started in the first place (says critics).
4. Effect on Consumers; Even when the government does win, it is not clear that the public benefits. Breakups of trusts have lead to increased prices by local companies.
5. Big Business Growth is Natural; all of the businesses now are all bigger than they were when the major antitrust laws were enacted. Moreover, these large power blocs offset the power of big business.
6. Big Business Benefits Small Business; Small companies feed off the large companies and have actually increased in number rather than disappeared as a result of the growth of big business; for example, all of the car dealerships, etc. that exist because of the huge automobile market.
· Holding Companies are organized for the purpose of owning or "holding" a controlling interest (over 50%) in other corporations. This became the most important means by which companies combined to reduce competition, after trusts were declared illegal.
· Interlocking Directorates is when the same people sit on the boards of directors of several firms.
· Cartels are when independent firms formally agree to stop competing and work together to establish a monopoly. To make a cartel, one must control production levels (how much product is made) and control prices. By limiting production to an agreed level, the cartel creates a demand for the product, which, in turn leads to increased prices. This is illegal in the United States but legal elsewhere in the world.
· Mergers occur when one corporation absorbs another. There are three types of mergers:
1. Horizontal Merger is when two or more companies engaged in the same line of business are brought under one management, like two airplane companies (as described in the book), or any two other similar types of companies. This is done primarily to reduce competition and lower certain kinds of overhead by eliminating redundancies.
2. Vertical Merger is when two or more firms engaged in different stages of marketing or producing the same good or service combine under a single ownership. For example, USX Steel owns its own iron mines, shipping companies, and steel mills, all different stages of production.
3. Conglomerate Merger involves when two or more companies combine which have unrelated products or services. The federal government is more likely to approve a conglomerate merger because conglomerate mergers are least likely to reduce competition. Why do conglomerates merge?
· As a way of spreading or cushioning the impact of hard times; when business is bad for one industry in a conglomerate, it may be better for another industry in the same conglomerate.
· To gain entry into a line of business at a lower cost than if the acquiring company had to start fresh.
· To buy a company undervalued by the stock market at a bargain price.
· To take advantage of loopholes in the tax laws.
· To invest surplus funds.
· To benefit from economies of size.
· Productivity is a measure of how many units of output are produced for every unit of input.
· Labor Productivity is expressed as the output per worker per hour. (x products ÷ y hours = z amount of products/hour. z amounts of products/hour ÷ a workers = __ products/hour/worker )
· Law of Diminishing Returns states that when we add additional factors of production such as workers or machinery, productivity usually increases. Eventually, though, a point is reached where the addition of inputs (workers or machinery) has the opposite effect, and production begins to decline. Why does this happen? Eventually the productivity is hampered by a lack of fixed resources (space to work, machinery, tools, etc.)
· Capacity is the potential output.
· Division of Labor, or Specialization refers to the fact that most, if not all factory workers do not contribute to the complete manufacture of a product from beginning to end. Instead, they work in one specialized area. What are the advantages of specialization?
13. A worker needs to be trained in only one operation or process. Therefore, with this training, a worker can soon become highly skilled at one job.
14. Because the task has been subdivided, it is easier to perform. Instead of hiring a highly trained worker to assemble the product from start to finish, the company hires less-skilled workers (at a lesser price) to complete each part of the task.
15. Supervisory and management responsibilities may also be subdivided with specialization. Like other workers, supervisors and managers will be able to attain a higher level of expertise in a few specialized tasks than they would if they were responsible for all production from beginning to end.
· Quantity Discounts are discounts offered to larger firms because of the size of the order. Suppliers are especially eager to keep their biggest customers, and frequently offer the large firms raw materials at lower prices than they sell to small firms.
· Specialized Machinery is available mainly to those who engage in large-scale production and the division of labor makes specialized machinery all the more practical. Large firms can more easily afford to purchase such machinery.
· Access to Credit is easier for large firms to attain, since the large firms are better known, and because their size makes them appear to be less of a risk.
· Research, Development, and By-Products are easier to come by in larger firms, since they are better able to invest in the equipment needed to research, develop and produce products.
· Diseconomies of Scale is the point when a firm grows beyond the point where the economies of large-scale production are effective. (When the increase in income resulting from the firm’s expansion will be less than it’s increased cost of operation.)
Unit Production Costs is the average costs of producing an item.
Chapter 12 (Assignment 11)
"…but in this world nothing can be said to be certain but death and taxes…" –Benjamin Franklin
· Taxes – Why do governments tax?
16. To Pay for the Cost of Government – The government spends billions of dollars on national defense, police, education, roads, public buildings and other matters. The majority of this money comes from taxes.
17. To Redistribute Wealth – Taxes redistribute wealth by taking money from some people and giving it to others. A good example is Medicaid; Medicaid pays the medical bills of poor people. Funding for Medicaid comes from taxes. Poor people (Medicaid recipients) pay little or no taxes. Therefore, funding for the Medicaid recipients comes from wealthier tax payers.
18. To Promote Certain Industries – Some taxes, such as Tariffs are designed to benefit certain industries. These taxes may make it easier for United States companies to compete with other foreign imports.
19. To Influence Consumer- and Business-Spending Patterns – The level of taxation affects the amount of money individuals and business firms spend or invest.
20. To Discourage Certain Behavior – Taxes designed to discourage what some members of society consider to be improper or unhealthy behaviors are often known as "sin taxes." Good examples include alcohol taxes and tobacco taxes. (That's why alcohol and cigarettes are getting so expensive… which none of you should know about anyways, being in our good little yeshivah… right… anyways…)
· Tariffs raise money for the government and/or raise the cost of imports from a foreign country.
11. Tariff is a tax on goods entering the country from a foreign country.
12. Protective Tariff is a tax designed to raise the cost of imports.
Federal Income Taxes
· Federal Income Tax is the principal source of revenue for the federal government. It is a progressive tax. This tax is automatically withheld by employers from employee’s paychecks. If one is self-employed, (For Jo Safdie, and all those Syrians out there…) you are required to estimate your tax liabilities for the coming year, and pay it in four equal installments. (Then again, if you pay cash under the table, there’s no way the IRS can know exactly how much you owe anyways, is there?)
· Internal Revenue Service (IRS) is the federal agency that collects income taxes.
What one earns in a year is more than one’s Taxable Income. There are three reasons why:
9. Some forms of income are excluded from taxation
10. Certain exemptions and deductions can be taken against one’s income
11. Some individuals are entitled to tax credits.
· Income Not Subject to Taxation includes interest earned on state and municipal bonds, inheritances and most Social Security payments, but they must be reported to the IRS. Welfare benefits need not be reported to the IRS and they are not subject to taxation.
· Exemptions and Deductions – Taxpayers are entitled to reduce their taxable income with an exemption for each of their dependents, including themselves. One effect of these exemptions is that low-income families end up paying very little taxes, and large families are given a tax break. In addition, amounts paid for state and local taxes, real estate taxes, mortgage interest, charitable gifts, and medical expenses may be deducted from one’s taxable income.
· Standard deduction another deduction – an amount (single people get less of a deduction than married people) of money that changes from year to year.
· Progressive Taxes are taxes that vary directly with the taxpayer’s income. People with higher incomes pay greater tax rates.
· Income Tax Credits – After reducing one’s earnings to eliminate those items not subject to tax, a taxpayer calculates his or her income tax liabilities. This may be reduced if the taxpayer is entitled to certain tax credits. These credits are offered for two purposes:
9. To promote certain activities
10. To help specific groups of individuals
· Earned Income Credit is available to certain low-income families. It allows families to reduce their tax liabilities by an amount that depends upon the number of its children and the earned income of that family. If the EIC is greater than the tax that the family would ordinarily pay the IRS, the family can actually receive a check from the government for the amount of the difference.
Critics of the Income Tax maintain that:
7. Tax Laws are too difficult to understand, and need to be simplified.
8. Favors the Rich at the Expense of the Poor – Wealthy people with surplus capital to invest can afford to invest in tax-free state and municipal bonds and hire expensive tax accountants to find numerous legal tax loopholes so as to avoid paying maximum taxes.
9. Discourages Incentives and Investments
· Corporate Income Tax pays for about 11 cents of every dollar raised by the federal government. Taxes on net profits increase proportionately with the size of these profits. The Corporate Income Tax receives the following criticisms:
7. The corporate tax subjects the owners of corporations (the stockholders) to double taxation. (Corporations are taxed on their profits, and the stockholders are taxed on the dividends they receive from those profits.)
8. The corporate tax discourages economic growth because the money taken by government might have been used by corporations to expand their production.
9. Some or all of the corporate income tax is passed on to consumers in the form of higher prices. If this happens across the country, the cost of living rises, in a process known as inflation.
· Excise Taxes are taxes levied on the manufacture or sale of particular goods and services, such as alcoholic beverages, gasoline and tobacco.
· Estate Taxes are levied on a person’s property at the time of death. There is a sizable exemption, and many legal loopholes that allow the wealthy to reduce the impact of the estate taxes.
· Gift Taxes was created to prevent wealthy persons from giving their property away so that their heirs would escape paying state taxes. Thus, gifts in excess of specified limits are subject to federal taxation.
State and Local Taxes
· Sales Tax is a percentage of the sales price on certain retail sales of goods and services.
· Gross Receipts Taxes are calculated taxes that are a percentage of a firm’s receipts from wholesale as well as retail activities.
· Real Property Taxes are levied upon buildings and land. The taxpayer’s holdings are assessed, and depending on the amount of money needed, a certain percentage of all taxpayer’s holdings are taxed. (Confusing – See page 286)
· Personal Property Taxes are levied on valuable items such as jewelry, furniture, securities, clothing and automobiles. This tax is uniformly assessed.
· User Taxes are taxes imposed on people who use a product or service. This includes gasoline taxes, license and registration fees, etc.
· Personal Income Taxes see above, under Federal Income Taxes.
· Inheritance Taxes see above, under Federal Income Taxes.
· Payroll and Business Taxes are often used to finance unemployment insurance programs, as well as health, disability and retirement programs. This tax is often collected by state and local governments.
· Corporate Income Taxes see above, under Federal Income Taxes.
· Unincorporated Income Taxes are sometimes imposed on businesses that are not corporations.
· Grant-in-Aid Programs are sums given for a specific purpose by the federal government to states and localities, or by states to localities.
Chapter 12 (Assignment 12)
· Underground Economy describes participants who conceal income from their activities because they are attempting to evade paying taxes on this income, because the activities are illegal, or both.
What are the Ingredients of a Good Tax System? Adam Smith decided that the tax must meet three criteria, and modern economists added the fourth criteria:
6. Fairness – Taxes must be fair, and taxpayers must believe that they are fair. Smith believed that governments should require taxes that were proportionate to income.
7. Clarity and Certainty – Everyone should be able to understand what the rate of the tax is and how the tax is to be paid. Smith believed that people would be more willing to pay their taxes if they knew what was expected of them.
8. Simplicity and Efficiency – Taxes should be easy to collect, difficult to evade, and inexpensive to administer.
9. Flexibility – Taxes should adjust to economic conditions.
· Fairness in Taxation – Everyone agrees that taxes need to be fair. But what makes a tax fair? Who should pay taxes and how much should they pay? Answers to this question depend upon benefits received, and ability to pay:
7. Benefits-Received Principal says that the taxes should be paid in proportion to the benefits that they receive from the government; the more benefits they receive, the more taxes should pay. This does not always work; it would be absurd to expect the poor to pay the tax that benefit the poor, and it would be impractical to expect for all of public education to be financed by those who use public education.
8. Ability-to-Pay Principal says that people should be taxed in accordance with their ability to pay; those who earn more, pay more, and those who earn less, pay less.
· Proportional Taxes are taxes that require all people to pay the same percentage of their total income. Advocates argue that this is the only fair tax, because it takes ten times as much in taxes from someone earning ten times more in income. However, according to Engel’s Law, this isn’t true.
· Engel’s Law states that the proportion of family expenditures for necessities (basic food, clothing and shelter) increases as income decreases, while the proportion of expenditures for luxuries (expensive clothes, jewelry, and expensive houses) decreases as income decreases. Therefore, a family that earns $15,000 a year, and needs to spend 90% of it on necessities ($13,500) will only have $1,500 (10%) available for luxuries. Now if the tax is 20%, they must pay $3000. This takes away all the luxury money as well as cutting into the necessities money. On the other hand, a family that earns $150,000 might only need to spend 30% of it on necessities ($45,000) and the remaining 70% (105,000) can be used for luxuries. If this family had to pay a 20% tax, it would come out to $30,000, an amount that is easily taken out of the luxuries, and a number that doesn’t even touch the necessities, as it did to the poorer family.
· Progressive Taxes are taxes where the percentage of income paid in taxes increases as one’s income increases. (Example: Federal Personal Income Tax)
· Regressive Taxes are taxes where one pays a larger fraction of one’s income as income decreases, and a smaller fraction as income increases. (Example: Sales and Excise Taxes) How does this work? Lets say that the tax on a car comes out to $1000. Person A makes $20,000. For person A, this tax is 5%. Person B makes $100,000. For person B, this tax is 1%. Therefore, the tax is proportionately more for the person who has the lower salary. The tax amount in dollars remains the same; the percentage is more for the person with the lower salary. Now look again at the definition.
· Shifting is the process of transferring the burden of a tax from those upon whom it is levied (in many cases, the merchants) to another individual or business.
· The Incidence of a tax refers to those on whom the burden of a tax finally falls (whoever ends up really paying the tax).
· Direct Taxes are taxes that are levied on people and cannot be shifted. (Example: Income Taxes)
· Indirect Taxes are taxes that can be shifted to others. These taxes are usually levied on goods and services. (Example: Sales Tax)
· Value-Added Tax (VAT) is like sales tax, except it is levied at every stage of production and distribution. What are the advantages of a VAT?
4. They are levied at every stage of production.
5. Value-added taxes are easy to collect and difficult to evade.
6. The VAT could make it easier for U.S. firms to compete abroad because VATs are usually levied only on sales inside the country that imposes the VAT.
· Energy Taxes are taxes on products such as oil, coal, gasoline, natural gas and other resources that produce heat, power electricity, or fuel for air, land and sea vehicles. Why would this tax be imposed?
1. To raise revenue.
2. To reduce consumption of energy.
Unfortunately, by nature, this tax would be regressive.
· Flat Taxes is a single rate tax on all incomes above a certain level. Since people would be taxed on a greater amount of their earnings, tax rates could be significantly lower than they are now. What are the disadvantages?
1. Charitable donations would no longer be tax-deductible, and many fear that there would be decreased donations as a result.
2. States and local governments would no longer be able to borrow money as they do now, because the bonds would no longer be tax-free.
3. Mortgages would no longer be tax-deductible, leading to increased difficulty in buying homes.
4. This tax would benefit the rich, and place the majority of the burden on the middle and lower class (see Engel’s law).
Chapter 14 (Assignment 13)
· Money has value only when it can be exchanged for goods and services.
· Barter is the exchange of something of value for a desired item.
· Counterfeiting is an attempt by any other group or organization to produce money.
· Legal Tender is currencies that must be accepted in payment for debts.
· Token Money is money whose metallic value is less than its face value.
· Drawer is a person writing a check.
· Drawee is the bank upon which the check is drawn
· Payee is the person who cashes the check.
Money has many functions:
21. It is a medium of exchange
22. Standard of Value - All goods and services can be measured by the same standard of value.
23. Store of Value - Since money can be saved for future use, you can store value for later.
Money has many characteristics:
13. Durability - Money should have the ability to stand up under use.
14. Portability - Money should be light enough to be carried.
15. Divisibility - Money should be capable of being divided into change.
16. Uniformity - Every unit of money should be similar to every other unit of that denomination.
17. Ease of Recognition - Money should be identifiable as such by everyone who sees it.
18. Relative Security - In order to be usable, money should be scarce. If it is too easily obtainable, people will be able to pay whatever price is asked. If that happens, prices will continue to rise until money becomes worthless.
19. Stability - Money's value should not rapidly change.
· Gresham's Law states that "cheap money drives out dear [expensive] money." This law states that when two or more kinds of money having the same nominal value circulate, the one considered more valuable is hoarded and disappears from circulation. (See page 333 and 334 for two examples in real life of this law.)
Types of Money
· Currency is money issued by the federal government.
· Fiat Money is money that has value because the government says that it does, not because of its natural value. (Example: The paper that a hundred-dollar bill is certainly not worth $100.)
· Coins or "Fractional Currency" is produced primarily for the convenience of making change.
· Paper Currency or Federal Reserve notes are paper bills that are worth a set amount of money.
· Checks are written orders directing a bank to pay a specified amount of money to someone. This is how most transactions in this country are accomplished.
· Demand deposit is a deposit in a bank that promises to pay on demand an amount of money specified by the customer who owns the deposit.
· Traveler's Checks are checks that are issued by a large bank, and may be used in lieu of money.
· Minting is the manufacture of coins.
· Monetary Standard is the commodity or definition a society uses for its money.
· Bimetallic Monetary Standard was the system used until 1900. Two metals - gold and silver - served as the basis of our monetary system.
· Gold Standard was the system used from 1900 until 1933. The dollar was defined in terms of gold, and the government would buy or sell gold at a standard price to individuals.
· Modified Gold Standard was the system adopted during the Great Depression. The value of the dollar and other currencies would continue to be based on gold, but individuals could no longer own gold.
· Fiat Currency Standard (Paper Money Standard) was the standard adopted in August 1971, when the United States government announced that it would no longer sell its gold for dollars even to foreign governments. Gold is now treated like any other commodity, like tin, or wheat, and the marketplace determines its price.
· Fluctuate is the economic term for prices moving up or down.
· Inflation is defined as a period of generally rising prices. The value of the dollar falls during periods of inflation because it buys less than it once did.
· Deflation is defined as a period of generally falling prices. The value of the dollar rises during period of deflation because the dollar can buy more than it once did.
Chapter 14 (Assignment 14)
· Fluctuate is the economic term for prices moving up or down.
· Inflation is defined as a period of generally rising prices. The value of the dollar falls during periods of inflation because it buys less than it once did.
· Deflation is defined as a period of generally falling prices. The value of the dollar rises during period of deflation because the dollar can buy more than it once did.
· Index number expresses percentage change from a base year.
· Consumer Price Index (CPI) is the index number most frequently used to measure changes in the value of the dollar. The CPI assigns a value of 100 to the average of prices from 1982-1984, which the base period used by the book. In 1990, the CPI was 130.7, which meant that prices had increased by 30.7 percent between the base years and 1990 (because 130.7-100 = 30.7).
· Base Period is a period chosen as an average year economically. This year changes periodically.
· Purchasing power is the way of expressing the cost of living in terms of dollars and cents. If the cost of living has doubled since the base years, one would say that the value of the dollar stands at $.50, or that what now costs $20, cost $10 during the base period.
· Annuities are funds purchased for a fixed sum in order to provide income (usually the same money with accumulated interest or dividends) at a later, agreed upon time.
· Debtors are people who owe money.
· Stagflation is an economy experiencing inflation at the same time as its resources are underutilized.
· Wage-price spiral is a series of inflationary price increases. Where does it start? Management maintains that the principal cause of inflation is the unions' demands for wage increases that outrun productivity. Unions argue that wage demands are merely efforts to make up for increases in the cost of living, which is caused by the price increases by business.
· Commodity Inflation describes run-ups in the prices of certain key commodities as the source of general price increases.
How Inflation Affects the Economy and People's Lives
Consumer prices have risen every year since 1939 (with the exception of 1949 and 1955), but prior to 1965, the annual cost of living increase was rarely more than 1.5 percent. However, after 1965, the rate of increase began to rise. From 1965 to 1970, the rate increased by 4 percent per year; from 1970 to 1975, the rate increased by 7 percent per year; from 1975-1980, the rate increased by 9 percent. In 1974, 1979 and 1980, double-digit inflation (when the cost of living increases by double digits) hit the country.
How does this affect the Economy?
Inflation can wreck an economy, and even an entire society; Germany is a prime example. Before World War I, in 1914, four marks (the German currency) could be exchanged for a dollar. By 1923, it took 4,000,000,000,000 (four trillion) marks to buy a dollar. The cost of living in Germany had increased a trillion times.
How does this affect the individual?
12. Savers and Investors store money in the bank, and in other investments where they feel that they will get the greatest gain. However, savers and investors must take into account the inflation rate. What might have cost $1,000 dollars when it was saved or invested may cost $1500 when the money is withdrawn. Therefore, since money loses its purchasing power during inflationary times, people with surplus funds frequently look for investments that will increase in value as fast or faster than the cost of living (real estate, gold, gems, rare stamps, antiques, works of art etc.).
13. People on Fixed Incomes find that, since their income is fixed (it stays the same from year to year), during times of inflation their money buys less. (See Annuities)
14. Business Firms find that the extent to which individual firms are affected by inflation depends upon a firm's ability to cover its increased costs. If the firm can raise its selling price without affecting any loss in the volume of sales, or if the firms costs of business have increased by less than the amount of the inflation, than the firm is fine. Otherwise, the business experiences a loss.
15. People Who Owe Money (Debtors) Debtors (see terms) generally profit from inflation if the value of the money they repay is less than the amount of their loans. If your loan was for $1,000 dollars and payable in two years, and inflation averaged 10 percent per year, you end up paying only $800 worth of purchasing power ($1,000 - 20 percent of $1,000 [$200] = $800). One economist quipped: "It's rather like borrowing steak and repaying the loan with hamburger."
16. People Who Lend Money can be hurt by inflation for the same reason that borrowers may profit: the value of the money that lenders lend is worth more than the value of the money that borrower repays. Oftentimes, lenders incorporate the inflation rate into the loan.
What are the Causes of Inflation?
11. Demand-Pull Inflation is brought on when the demand for goods and services outpaces the economy's ability to produce them. In this situation, prices will necessarily increase. One economist described demand-pull as a situation in which "too much money was chasing too few goods." Where does the excess demand come from?
· Federal Government - The government can spend more money than it earns in taxes and other revenues. This leaves the public with more money and more purchasing power than it had before, driving up prices. The government can also increase the money supply through the Federal Reserve System.
· Changes in Spending Habits of Individuals and Businesses can drive up prices with increased demand for a product.
· Public Expectations can also lead to inflation. If the public believes that prices will rise in the future, and they rush to buy now, this can drive up prices, which in turn leads to inflation.
10. Cost-Push Inflation is a run-up in prices that results as sellers raise their prices because of increases in their costs. (See terms, including stagflation, wage-price spiral, and commodity inflation.)
Measuring the Nation's Money Supply
Economists apply four different measures of the money supply to distinguish one from others.
· M1 is paper currency and coin, checking accounts and traveler's checks.
· M2 is M1 plus savings accounts, money market funds, money market deposit accounts, and small certificates of deposit.
· M3 is M2 plus large denomination certificates of deposit ($100,000 or more) and other large funds.
· L is M3 plus savings bonds, short-term Treasury securities, banker's acceptances, and commercial paper.
Chapter 17 (Assignment 17)
· Commercial Banks provide business firms with checking accounts. They also extend loans to businesses and consumers.
· Thrift Institutions refer to three types of institutions:
24. Savings and Loan Associations. A savings and loan association is interested primarily in home financing. Therefore, virtually all of its loans are in the form of long-term mortgages. Many also offer interest-bearing checking accounts, credit cards, and Individual Retirement Accounts, traveler's checks, government bonds, and consumer loans.
25. Mutual Savings Banks. Depositors in a mutual savings bank are part owners of the bank. Theoretically this gives them a voice in the management of the bank and a claim against its assets in the even of its liquidation. In practice, however, professional managers operate mutual savings banks with very little direction from depositors. The principal function of mutual savings banks is to accept deposits and use those funds to make loans. Depositors entrust their savings to these banks for safekeeping and for income, which is paid in dividends and interest. Some mutual savings banks compete with commercial banks, by offering regular and interest-bearing checking accounts to individuals and nonprofit organizations. They also offer short-term consumer loans, financial services (such as investment and retirement accounts), credit cards, and safe-deposit boxes.
26. Credit Unions. Like mutual savings banks, credit unions are owned by their depositors. However, credit unions limit membership to those who belong to a particular group, such as workers at a business establishment, members of a labor union, or employees and students of a university. Credit Unions are non-profit organizations.
· Mortgage is a loan that is secured by the property that was purchased with the borrowed money.
· Assets are everything of value owned by a business. Anything else is known as a liability. The difference between a banks assets and liabilities is its net worth.
· Cash in Vault which is the money that the bank has on hand to use.
· Reserve Account with Federal Reserve Bank is where the banks keep most of their reserves of cash.
· Loans are classified as assets because they are owned by the bank and represent obligations payable to the bank. (You don't know what a loan is, beat yourself. Please.)
· Securities (such as government bonds) are safe places for banks to put their funds when they cannot find a borrower for the money.
· Buildings and Fixtures are also classified as assets, since the bank can presumably sell these for money.
· Demand Deposits are those that can be withdrawn at any time, such as checking accounts.
· Time Deposits are usually left in banks for longer periods of time than demand deposits. Savings deposits are subject to advance notice of withdrawal, but as a rule they are available to customers whenever they choose to withdraw them.
How Banks Make Money:
· Interest is expressed as a formula where
I = P x R x T
I = Interest
P = principal (amount borrowed)
R = rate (of interest per year)
T = time (in years or fractions of years)
· Federal Deposit Insurance Corporation (FDIC) and Federal Savings and Loan Insurance Corporation (FSLIC) are insurance companies that pay you if your bank fails, up to $100,000. In the '80s so many banks were failing that neither the FDIC nor the FSLIC had enough in their reserves to guarantee the deposits of all the failed institutions. Therefore, the:
· Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) was established, to:
20. Bolster the enforcement powers of the agencies that regulate thrift institutions.
21. Strengthen the deposit insurance programs.
Chapter 16 (Assignment 16)
· Central Bank is a national institution that has the responsibility for:
27. Providing banking services to the government and to private banks.
28. Supervising every other bank in the country.
29. Controlling the volume of bank credit..
30. Coordinates the nation's supply of money and credit.
It deals mainly with other banks and the national government.
· National Banking System was a system of federally chartered banks authorized to issue notes backed by United States government bonds. This was created by the National Bank Act (1863).
Weaknesses of the National Banking System
22. Inflexibility of Bank Credit - Banks could lend only up to the limit permitted by their reserves. Once the limit was reached, however, new lending stopped. There was no central agency to help banks that needed more cash to lend or to provide additional reserves. Thus, credit became tight.
23. Inelastic Money Supply - The amount of national banknotes was relatively fixed; there was no way of increasing or decreasing the money supply.
24. Inefficient System of Clearing and Collecting Checks - Clearing checks under the National Banking System was inefficient and slow.
25. The Uncontrolled System of Redeposited Reserves - Before 1913, it was the custom for small town and rural banks around the country to deposit their reserves in big city banks that offered high interest rates. During hard times, business activity declined. When businesses withdrew funds to cover expenses, and word spread about heavy withdrawals and business failures, nervous depositors lined up to withdraw their savings. This is known as a run on a bank.
· Run on a Bank is when many depositors make large withdrawals all at once. During a run, the bank might refuse to pay out currency.
· Elastic Currency is one that expands and contracts with the needs of business. ?
· Federal Reserve Act (1913) created the Fed, or the Federal Reserve System.
· Federal Reserve System functions as the United States' central bank. The Fed is composed of a Board of Governors located in Washington, D.C. and 12 District Reserve Banks, each serving a different geographical location. This system was chosen to:
17. Avoid placing too much power in the hands of a single bank.
18. Meet the special needs of the regions.
The Fed supervises individual banks to ensure that business is done in a safe and legal manner and that consumers are being treated fairly. The Fed also oversees the nation's banking system in the following ways:
12. District Banks Hold the Nation's Reserve - Banks are required to keep a certain percentage of their deposits in reserves.
13. Supplies the Nation's Currency and Coin - All new money printed or minted by the United States Treasury is put into circulation by the Federal Reserve System.
14. The Federal Reserve System Clears Checks (see p. 380 for a detailed description of the process)
15. Electronic Funds Transfer - All the transactions that used to be accomplished by checks are now accomplished electronically.
· District Reserve Banks are owned by the member banks in their districts. All member banks are required to purchase the stock of its District Reserve Bank. However, the control of the Federal Reserve System remains in the hands of the federal government.
The Structure of the Federal Reserve System
Board of Governors - 7 Members
Federal Reserve Banks - 12 Banks 25 Branches
Depository Institutions - 39,000 Individual Banks and Branches
· Board of Governors supervises the many activities of the Federal Reserve System (see terms). The board establishes and oversees the nation's monetary policies. The seven members of the Board of Governors are appointed by the president of the United States subject to the consent of the Senate for fourteen years. The Chairperson is appointed from among the members by the president for a four-year term.
· Member Banks make up forty percent of the nation's bankers, including all national banks.
· Federal Open Market Committee is the most important policy-making group of the Fed. It directs the purchase and sale of government securities, thereby affecting the nation's supply of money and credit.
· Federal Advisory Council is a 12 member committee of bankers that meets several times a year to advise the Board of Governors on matters of current interest.
Monetary Policy and the Fed
If the price level (P) is determined by the amount of money (M) and the quantity of goods (Q), it follows that increasing or decreasing M or Q will affect prices. Therefore, if the government is to control inflation in our economy, it needs to regulate the amount of goods produced, the money supply, or both. How do they control these factors?
11. The amount of money that individuals and business firms can spend depends in part upon how much they can borrow. When credit is readily available at a reasonable price, spending and business activity increase. When credit is tight (less available) spending and business activity decreases.
12. The Fed can regulate the level of economic activity through its control over the money supply. There are times when the economy as a whole could benefit from an increase in the money supply. At other times, a decrease is required. The Federal Reserve System has a number of terms that it uses to regulate the supply of money and credit. These tools are:
· The Reserve Ratio is also known as required reserves. A bank must keep a certain percentage of its total deposits in reserve.
· The Discount Rate is the interest charged on loans to other banks who borrow money when the reserves run low.
· Open Market Operations is the buying and selling of government bonds by the Federal Open Market Committee. The effect of open market operations is magnified by the deposit multiplier (see terms).
10. When the Fed buys securities, its payments are usually deposited in the sellers' bank accounts. This action increases bank reserves, thereby making more money available for the bank to loan. The Fed gets individuals and institution to sell securities by offering whatever price is necessary to convince holders of securities to sell.
11. When the Fed sells securities, the payments that it receives reduce the balances in the buyers' accounts. This action reduces bank reserves, thereby decreasing the amount of money the banks can loan. The Fed gets individuals and institutions to buy securities by lowering the asking price of the securities it wishes to sell so as to make these securities attractive to buyers.
· Deposit Multiplier is the number of times deposits could be increased by the banking system for every dollar in reserves. The deposit multiplier is equal to 100 divided by the reserve ratio.
Chapter 17 (Assignment 17)
Measuring the Nation's Economic Performance
· Economic Indicators are sets of data about the performance of a segment of the economy:
31. Leading - These economic indicators move ahead of the economy. One sees leading economic indicators going up and down before the economy actually responds. (Example: an increase in employment tends to lead to an increase in business.)
32. Coincident - These economic indicators move up and down along with the economy. They let one know where the economy is in the business cycle. (Example: Industrial Production Index which measures changes in output in the nation's factories, mines and utilities.)
33. Lagging Indicators - These economic indicators tend to move behind the current economic trends, and reach their highs and lows later than the business cycle. (Example: an increase in unemployment rate follows the beginning of a recession.)
· GDP (same as GNP in Chapter 2) is the total output of goods and services purchased by consumers, business, and government, and by international buyers of United States goods and services. The formula is:
C (Consumption) + I (Investment) + G (Government Expenditures) + X (Net Exports) = GDP
One way of calculating the GDP is by tallying the following expenditures, a process known as the Expenditure Approach.
· Personal Consumption Expenditures is made up of all consumer spending, including durable goods (long-lasting items), nondurable goods (quickly consumed items), and services.
· Gross Private Domestic Investment constitutes the sum of spending by businesses for new equipment, construction and changes in business inventories of raw materials, partially finished goods, and finished goods.
· Government Purchases of Good and Services include spending by all levels of government including federal, state and local.
· Net Exports of Goods and Services is the difference between the imports (see terms) and exports of the country.
Another way of calculating the GDP is by tallying the following incomes, a process known as the (surprise, surprise) Income Approach:
· Compensation of Employees includes their wages, salaries, and other benefits such as insurance, etc.
· Proprietors' Income is the profits earned by owners of the nation's unincorporated businesses in a year.
· Corporate Profits is the profits earned by a corporation in a year.
· Rental Income includes payments to landlords for the use of property, and royalty payments.
· Net Interest is the difference between the total interest received and that paid out by the business sector in a given year.
· Capital Consumption, also known as "depreciation" represents sums that businesses have to set aside to replace plant and equipment worn out in the course of producing the GDP.
· Indirect Taxes include the sales and excise taxes that we pay.
· Final Goods are the only ones included in the GDP - the intermediate steps are not calculated.
Constant Dollars: Correcting for Changes in the Price Level
The value of the dollar (in terms of what it can buy) is subject to change. For that reason, comparisons of the GDP from one year to another can be misleading. Therefore, the Constant Dollar expresses the value of dollars in terms of their purchasing power in the base year.
· Imports represent United States purchases of foreign goods and services.
· Exports represent the sale of United States products and services to foreigners.
· GDP Per Capita is the economic term used to compare productive output and living standards of two or more nations.
Limitations of the GDP
26. Failure to Include "Nonmarket" Economic Activities: While the GDP is supposed to represent the total value of all goods and services produced by the economy, a large chunk is not included, such as the labor that performed but not paid for. (Example: Cleaning the house* or caring for children* cooking* gardening* etc.)
*Syrian translation: Watching the hadema work : ) I'm just kidding!
27. Failure to Measure Economic Well-Being: Although the GDP tells us whether total output is increasing or decreasing, it does not tell us anything about the quality of that output. (Example: $1 Billion worth of cigarettes is equal to $1 Billion in grain in the GDP.)
Other National Income Accounts: (Measures of income often reported on by the news media.)
19. National Income - The sum total of all the earnings including salaries and wages, rent, profits, and other returns such as interest and dividends.
20. Personal Income - The total of income received by individuals and families before they pay their income taxes is personal income, including wages, dividends, interest, rent, government payments, and transfer payments.
21. Disposable Personal Income - The total income remaining after personal income taxes have been paid.
Aggregate Demand, Full Employment, and the Price Level
The nation's total output of goods and services (GDP) is purchased by three principal groups: consumers, producers, and government. This total sum is referred to as the aggregate demand. I don't understand this.
The efforts of the federal government to stabilize the United States economy were for many years based upon the theories of British economist John Maynard Keynes (Bio on p.404-405). Keynes had identified fiscal and monetary policies as keys to both ending recessions and bringing inflation under control. According to Keynes, in times of recession the government uses its monetary and fiscal powers to increase spending by consumers, business, and itself and vice versa.
Keynesianism worked until the 1970s when the nation found itself in the midst of both recession and inflation. Economists called this stagflation. The "supply-siders" found the solution to this problem because they saw production (that is, supply) as the key to ridding the nation of stagflation. The goal of the supply-siders was to "unleash free enterprise" so as to increase investment and production. If production were increased, prices would have to come down. Meanwhile, the additional investment in new equipment and enterprises would put the unemployed back to work, increase personal and business earnings, and bring the recession to an end.
Three obstacles to achieving these goals:
16. Income taxes were so high that they discouraged capital investment in new plants, equipment and business enterprises.
17. Government-sponsored welfare programs discouraged individual initiative. Why, the supply-siders asked, would people look for work if they knew that they could have as much money simply by going on welfare?
18. Government regulatory agencies discouraged innovation and creativity because rules were pervasive and strictly applied.
The proposed remedy was to reduce income taxes, particularly for those in the upper-income brackets. This reduction would leave businesspeople and others with additional after-tax income which could be invested in productive enterprises. Moreover, rich people would have greater incentive to earn more money.