McConnell Economics, Chapter 5

[Jin+Guice]

Discussion of the curriculum McConnell, Brue, Flynn Economics text, chapter 5.

[Jin+Guice]

The first section of this chapter discusses income distribution. The majority of income in the United States is paid in wages, with the rest being divided between corporate profit, small business owners, interest on debt and rent. In the United States the distribution of income is highly unequal.
In the United States, the savings rate is very low with most money flowing to personal consumption. In the U.S. about 12% of personal consumption expenditures are spent on durable goods, 30% are spent on non-durable goods and 58% are spend on services.

The second section discusses businesses. Vertical integration is defined as firms that own plants (stores) that different functions in the production process. Three legally different types of firms are defined and the distribution of their number and percentage of sales in the U.S. is presented. Sole proprietors make up 73% of businesses and 5% of sales, partnerships make up 7% of firms and 6% of sales and corporations make up the remaining 20% of businesses and 89% of sales. The legal protection of the owners of corporate entities is discussed (people may sue for business but not personal assets of the corporation, this include LLCs which can be partnerships or sole proprietors). This section introduces the principal-agent problem, a problem encountered by medium and large corporations. This problem occurs when the interests and incentives for the managers of a firm do not align with the owners of the firm. One solution, suggested by the text, is to compensate corporate executives with stock in the company, thus making them owners and, in theory, aligning interests.

The third section discusses the economic role of government in a market economy. The text suggests that the government is responsible for maintaining a legal structure conducive to trade, promoting competition with antitrust laws, forming utilities in the case of natural monopolies, redistributing income through transfer payments, market intervention and progressive taxation; Punishing firms for negative externalities* and rewarding positives ones; and ensuring providing public goods**.

*Externalities are costs or benefits of market transactions not captured by the market. Pollution, for example.**Public goods are goods that suffer from the "free-rider problem," that is, once they are constructed, it is not possible to exclude others from using them. Examples are a lighthouse or national defence. 

The final section largely discusses how government spending is financed. It begins with a discussion of circular flow, which sort of ties the chapter together. Money and goods flow between the consumers, businesses and the government through different markets and government transfer payments to businesses and consumers.

The federal government collects revenue from income tax (48%), social security and medicare taxes (34%), corporate income tax (10%), excise taxes on commodities such as alcohol, tobacco and gasoline (4%) and other unspecified sources (4%). They spend this money on Pensions and income security payments (39%), Healthcare (19%, but this is pre obamacare) National Defense (16%), interest on public debt (14%) and "other" (14%). 

States get tax funding from sales tax, state income tax, corporate income tax and license fees. They spend this money on education, public welfare, hospitals and highway maintenance. They also receive transfer payments from the federal government. Local governments obtain most of their revenue from property taxes and spend most of it on education.

[white belt]

Overall, I think this chapter provided a good overview of how the government interacts with a market economy. This explanation is what I felt like was missing from the previous chapter on free markets because it revealed some of the downsides of free market capitalism.

I found the requirement for a plant to have a physical establishment to be outdated, but perhaps this is a function of the text being ~20 years old. For example, a website that offers paid online courses for a cloud certification would not meet the definition for a business because it does not have a physical establishment?

What I've appreciated so far about the textbook is that it presumes almost no background knowledge. I find myself learning quite a bit about topics I already thought I completely understood because of the way the authors break everything down "Barney-style."

[mathiverse]

In this chapter, the distribution of spending by households is listed as being divided between the categories: personal consumption expenditures, personal taxes, and personal savings. Does that mean that debt payment for credit cards, home mortgages, etc would be considered a personal consumption expenditure?

Personal consumption expenditures are further broken into the categories: services, durable goods, and non-durable goods. Would the debt payments fall into the services category? Or maybe just the interest would be in the services category and the price of the object without the interest would be fall under durable good, non-durable good, or service as appropriate?

[jacob]

In this chapter, the distribution of spending by households is listed as being divided between the categories: personal consumption expenditures, personal taxes, and personal savings. Does that mean that debt payment for credit cards, home mortgages, etc would be considered a personal consumption expenditure?

Personal consumption expenditures are further broken into the categories: services, durable goods, and non-durable goods. Would the debt payments fall into the services category? Or maybe just the interest would be in the services category and the price of the object without the interest would be fall under durable good, non-durable good, or service as appropriate?

It's been a while, so caveat emptor.

It helps to remember that to consume means to destroy or obliterate. IOW, consumption is the final destination of a good or a service. Services are things someone else does for you. Goods are things someone else gives to you. (Note that whatever you do or give yourself doesn't count in the official economy. It just assumes those are zero whereas in reality they just have zero value to the economy. This is why economists get their minds blown when there's too much talk of DIY. The ERE world doesn't fit within the variable space of classical economics.) Goods can be short term or long term. Lets arbitrarily set a time limit of a year. Then short term is non-durable; like food, gas, electricity, socks. Durables are things like cars, TVs, computers, ... (When talking investments, durable goods tend to be cyclical ... people only buy them when they can afford them. Nondurables are non-cyclical because people consume them all the time. Clearly there are exceptions to this! Lobster dinners are non-durable but also cyclical. But rule of thumb ...)

Personal taxes is just the flow arrow pointing towards the government instead of spending which points towards businesses. Just think of them as different goods and service providers.

Savings should really be called "savings and investments". The difference here is that they are not consumed! Rather they are either saved for later spending OR to create goods or services that can be consumed. Debt and interest would go in here as negative numbers. E.g. you borrow 20k to buy a car. You now have a 20k car and a 20k hole in your savings. Your personal spending (relative to the aggregate) was zero because you spent someone else's money.

All this stuff only becomes useful once the sum-of-the-whole is seen as a giant stock&flow chart. It is mostly interesting because it allows economists to look at things in the aggregate. For example GDP = consumer spending + government spending + business investment + import/export(*); this all measures how much stuff is created/obliterated within the given country. Note how there's a bit of a word game going on here to make people feel better. E.g. if you buy a computer for yourself, it's spending on durable goods whereas if you buy it for your etsy business, it's suddenly a "business investment". In reality, the computer is consumed either way. I suspect this is why people sometimes convince themselves that their new work pants are an investment.

Why is this important? Because it matters who and what gets produced and consumed within a country. Imagine, for example, if you set up your own equations but instead of the consumer/business/government variables used demographic age groups by generation, e.g. GDP = silent + boomer + genx + mill ... and tried to analyze it that way. You would now be able to somewhat predict which investments were likely to do better. E.g. with silents dying and boomers getting older, there would be money flows into Ensure and Depend because those markets are getting bigger as boomers get older. And so on.

You can rotate into any set of variables you want. It's all the same [unitary] matrix. There was once a time when people did not look at the matrix and nobody knew what the GDP actually was.

(*) Import/export is interesting because you could draw boundaries everywhere. If you drew a boundary around yourself, then loans/etc. could be seen as part of the NX equation.

[mathiverse]

That was a very informative answer, thanks!

Note how there's a bit of a word game going on here to make people feel better. E.g. if you buy a computer for yourself, it's spending on durable goods whereas if you buy it for your etsy business, it's suddenly a "business investment". In reality, the computer is consumed either way.

That answers another question I had. McConnell says that "government purchases of such products as paper, computers," etc come from the product market. But despite the fact that businesses also buy paper, computers, etc there is no arrow indicating money flowing from businesses to the product market for those purchases. The word trickery explains why, in the circular flow diagram, businesses are shown to only buy from the "resource market" and not the "product market" even if the goods are the same as the ones that households and governments are buying in the "product market."

[7Wannabe5]

jacob wrote:
Note how there's a bit of a word game going on here to make people feel better. E.g. if you buy a computer for yourself, it's spending on durable goods whereas if you buy it for your etsy business, it's suddenly a "business investment". In reality, the computer is consumed either way.

I admit that I may be permanently rendered dense on this topic, but I still can't comprehend why the computer "consumed" for your tiny home-based etsy business from which you derive $X net income is any different from the computer "consumed" by the giant bloated corporate monopoly from which you derive $X dividend or capital gain income (given that wage one pays oneself and ROI are reasonable, maybe in alignment to what you "pay" yourself for cooking rather than going out to eat or other frugal activities or in alignment with wage of median worker for the giant bloated corporate monopoly.)