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CH
APT
ER
4
The U
.S. E
conom
y: P
riva
te a
nd P
ublic
Sec
tors
75
furn
itu
re,
and
per
son
al c
om
pu
ters
. A
no
ther
29
per
cen
t o
f co
nsu
mer
ex p
end
itu
res
are
on
no
nd
ura
ble
go
od
s—p
rod
uct
s th
at h
ave
live
s o
f le
ss t
han
th
ree
year
s. I
ncl
ud
edar
e su
ch g
oo
ds
as f
oo
d,
clo
thin
g,
and
gas
oli
ne.
Ab
ou
t 6
0p
erce
nt
of
con
sum
er e
xpen
dit
ure
s ar
e o
n s
erv
ices —
the
w
ork
do
ne
for
con
sum
ers
by
law
yers
, b
arb
ers,
do
cto
rs,
lod
gin
g p
erso
nn
el,
and
so
on
. T
his
hig
h p
erce
nta
ge
isth
e re
aso
n t
hat
th
e U
nit
ed S
tate
s is
oft
en r
efer
red
to
as
a se
rvic
e-or
ien
ted
econ
omy.
In d
iscu
ssin
g b
usi
nes
ses,
it
wil
l b
e u
sefu
l to
dis
tin
guis
ham
on
g a
pla
nt,
a f
irm
, an
d a
n i
nd
ust
ry:
• AA
pla
nt
is a
ph
ysic
al e
stab
lish
men
t—a
fact
ory
, far
m,
tm
ine,
sto
re, o
r w
areh
ou
se—
that
per
form
s o
ne
or
mo
re f
un
ctio
ns
in f
abri
cati
ng
and
dis
trib
uti
ng
goo
ds
and
ser
vice
s.•
A f
irm
is a
n o
rgan
izat
ion
th
at e
mp
loys
res
ou
rces
to
p
rod
uce
go
od
s an
d s
ervi
ces
for
pro
fit
and
op
erat
es
on
e o
r m
ore
pla
nts
.•
An
in
du
stry
is
a gr
ou
p o
f fi
rms
that
pro
du
ce t
he
y sa
me,
or
sim
ilar
, pro
du
cts.
Th
e o
rgan
izat
ion
al s
tru
ctu
res
of
firm
s ar
e o
ften
co
mp
lex
and
var
ied
. Mu
ltip
lan
t fi
rms
m
ay b
e o
rgan
ized
ho
rizo
nta
lly,
sw
ith
sev
eral
pla
nts
per
form
ing
mu
ch t
he
sam
e fu
nct
ion
.E
xam
ple
s ar
e th
e m
ult
iple
bo
ttli
ng
pla
nts
of
Co
ca-C
ola
and
th
e m
any
ind
ivid
ual
Wal
-Mar
t st
ore
s. F
irm
s al
so m
ay
be
vert
ical
ly i
nte
grat
ed,
mea
nin
g th
ey o
wn
pla
nts
th
at p
er-
form
dif
fere
nt
fun
ctio
ns
in t
he
vari
ou
s st
ages
of
the
pro
-d
uct
ion
pro
cess
. F
or
exam
ple
, o
il c
om
pan
ies
such
as
Sh
ell
ow
n o
il f
ield
s, r
efin
erie
s, a
nd
ret
ail g
aso
lin
e st
atio
ns.
So
me
firm
s ar
e co
ngl
omer
ates
,so
nam
ed b
ecau
se t
hey
hav
e p
lan
tsth
at p
rod
uce
pro
du
cts
in s
ever
al i
nd
ust
ries
. F
or
exam
ple
,P
fize
r m
akes
no
t o
nly
pre
scri
pti
on
med
icin
es (
Lip
ito
r,V
iagr
a) b
ut
also
ch
ewin
g gu
m (
Tri
den
t, D
enty
ne)
, ra
zors
(S
chic
k),
cou
gh
dro
ps
(Hal
ls),
b
reat
h
min
ts
(Clo
rets
, C
erts
), a
nd
an
taci
ds
(Ro
laid
s).
Le
ga
l F
orm
s o
f B
usi
ne
sse
s T
he
bu
sin
ess
po
pu
lati
on
is
ex
trem
ely
div
erse
, ra
ngi
ng
fro
m g
ian
t co
rpo
rati
on
s su
ch a
s E
xxo
nM
ob
il,
wit
h 2
007
sale
s o
f $34
7 b
illi
on
an
d t
ho
usa
nd
s o
f em
plo
yees
, to
nei
gh-
bo
rho
od
sp
ecia
lty
sho
ps
wit
h o
ne
or
two
em
plo
yees
an
dsa
les
of
on
ly $
200
to $
300
per
day
. T
her
e ar
e th
ree
maj
or
lega
l fo
rms
of
bu
sin
esse
s:•
A s
ole
pro
pri
eto
rsh
ipis
a b
usi
nes
s o
wn
ed a
nd
op
erat
ed b
y o
ne
per
son
. Usu
ally
, th
e p
rop
riet
or
(th
e o
wn
er)
per
son
ally
su
per
vise
s it
s o
per
atio
n.
• T
he
par
tner
ship
fo
rm o
f b
usi
nes
s o
rgan
izat
ion
is
a n
atu
ral
ou
tgro
wth
of
the
sole
pro
pri
eto
rsh
ip. I
n a
par
tner
ship
, tw
o o
r m
ore
in
div
idu
als
(th
e p
artn
ers)
ag
ree
to o
wn
an
d o
per
ate
a b
usi
nes
s to
geth
er. U
sual
ly
they
po
ol
thei
r fi
nan
cial
res
ou
rces
an
d b
usi
nes
s sk
ills
. C
on
seq
uen
tly,
th
ey s
har
e th
e ri
sks
and
th
e p
rofi
ts o
r lo
sses
. •
A c
orp
ora
tion
is a
lega
l cre
atio
n t
hat
can
acq
uire
n
reso
urce
s, o
wn
ass
ets,
pro
duce
an
d se
ll pr
oduc
ts, i
ncu
rde
bts,
ext
end
cred
it, s
ue a
nd
be s
ued,
an
d pe
rfor
m t
he
fun
ctio
ns
of a
ny
oth
er t
ype
of e
nte
rpri
se. A
cor
pora
tion
is d
isti
nct
an
d se
para
te f
rom
th
e in
divi
dual
sto
ckh
olde
rsw
ho
own
it. H
ired
man
ager
s ru
n m
ost
corp
orat
ion
s.
FIGURE 4.4
Th
e c
om
po
siti
on
of
co
nsu
me
r ex
pe
nd
itu
res,
20
07
.C
on
sum
ers
div
ide
th
eir
sp
en
din
g a
mo
ng
du
rab
le g
oo
ds
(go
od
s th
at h
ave
ex
pe
cte
d li
ve
s o
f th
ree
ye
ars
or
mo
re),
no
nd
ura
ble
go
od
s, a
nd
se
rvic
es.
Ab
ou
t 6
0 p
erc
en
t o
f
con
sum
er
spe
nd
ing is
fo
r se
rvic
es.
Dura
ble
goods
$1078 b
illio
n
(11%
)
Nondura
ble
goods
$2833 b
illio
n
(29%
)
Serv
ices
$5823 b
illio
n
(60%
)
Sourc
e:B
ure
au of Eco
fnom
ic A
nal
ysis
, www. bea.gov.
• T
he
fun
ctio
nal
dis
trib
uti
on
of
inco
me
ind
icat
es h
ow
in
com
eis
ap
po
rtio
ned
am
on
g w
ages
, ren
ts, i
nte
rest
, an
d p
rofi
ts; t
he
per
son
al d
istr
ibu
tio
n o
f in
com
e in
dic
ates
ho
w i
nco
me
is
div
ided
am
on
g fa
mil
ies.
• W
ages
an
d sa
lari
es a
re t
he
maj
or c
ompo
nen
t of
th
e fu
nct
ion
al
didistst
riribubu
titionon
o off
inincoco
me
me.
Th
Th
ee pepe
rsrsonon
alald d
isistrtr
ibibutut
ioionn
ofof
i inc
nco
momee
reve
als
con
side
rabl
e in
equa
lity.
• A
bo
ut
86 p
erce
nt
of
ho
use
ho
ld i
nco
me
is c
on
sum
ed; t
he
rest
is
save
d o
r p
aid
in
tax
es.
• C
onsu
mer
spe
ndi
ng
is d
irec
ted
to d
urab
le g
oods
, non
dura
ble
good
s, a
nd
serv
ices
, wit
h 6
0 pe
rcen
t go
ing
to s
ervi
ces.
QU
ICK
RE
VIE
W 4
.1
Th
e B
usi
ne
ss P
op
ula
tio
n
Bu
sin
esse
s co
nst
itu
te t
he
seco
nd
maj
or
par
t o
f th
e p
riva
te
sect
or.
Lik
e h
ou
seh
old
s, t
hey
are
a m
ajo
r el
emen
t in
th
e ci
rcu
lar
flo
w d
iagr
am t
hat
we
dis
cuss
ed i
n C
hap
ter
2.
PA
RT
ON
E
Intr
oduct
ion t
o E
conom
ics
and t
he
Eco
nom
y7
6
A c
om
mo
n s
tock
rep
rese
nts
a s
har
e in
th
e o
wn
ersh
ipk
of
a co
rpo
rati
on
. T
he
pu
rch
aser
of
a st
ock
cer
tifi
cate
has
the
righ
t to
vo
te f
or
corp
ora
te o
ffic
ers
and
to
sh
are
in d
ivi-
den
ds.
If
you
bu
y 10
00 o
f th
e 10
0,00
0 sh
ares
iss
ued
by
Ou
tTel
l, I
nc.
, th
en y
ou
ow
n 1
per
cen
t o
f th
e co
mp
any,
are
enti
tled
to
1 p
erce
nt
of
any
div
iden
ds
dec
lare
d b
y th
eb
oar
d o
f d
irec
tors
, an
d c
on
tro
l 1
per
cen
t o
f th
e vo
tes
in
the
ann
ual
ele
ctio
n o
f co
rpo
rate
off
icia
ls.
In c
on
tras
t, a
co
rpo
rate
bo
nd
do
es n
ot
bes
tow
an
y co
rpo
rate
ow
ner
ship
on
th
e p
urc
has
er.
A b
on
d p
urc
has
er
is s
imp
ly l
end
ing
mo
ney
to
a c
orp
ora
tio
n.
A b
on
d i
s an
IO
U, i
n a
ckn
ow
led
gmen
t o
f a
loan
, wh
ereb
y th
e co
rpo
ra-
tio
n p
rom
ises
to
pay
th
e h
old
er a
fix
ed a
mo
un
t se
t fo
rth
on
th
e b
on
d a
t so
me
spec
ifie
d f
utu
re d
ate
and
oth
er f
ixed
amo
un
ts (
inte
rest
pay
men
ts)
ever
y ye
ar u
p t
o t
he
bo
nd
’s m
atu
rity
dat
e. F
or
exam
ple
, yo
u m
igh
t p
urc
has
e a
10-y
ear
Ou
tTel
l b
on
d w
ith
a f
ace
valu
e o
f $1
000
and
a 5
per
cen
t ra
te o
f in
tere
st.
Th
is m
ean
s th
at i
n e
xch
ange
fo
r yo
ur
$100
0, O
T p
rom
ises
yo
u a
$50
in
tere
st p
aym
ent
for
each
o
f th
e n
ext
10 y
ears
an
d t
hen
rep
ays
you
r $1
000
pri
nci
pal
at
th
e en
d o
f th
at p
erio
d.
Fin
anci
ng
thro
ugh
sal
es o
f st
ock
s an
d b
on
ds
also
pro
-vi
des
oth
er a
dva
nta
ges
to t
ho
se w
ho
pu
rch
ase
thes
e co
rpo-
rate
sec
uri
ties
. A
n i
nd
ivid
ual
in
vest
or
can
sp
read
ris
ks b
y b
uyi
ng
the
secu
riti
es o
f se
vera
l co
rpo
rati
on
s. A
nd
it is
usu
-al
ly e
asy
for
ho
lder
s o
f co
rpo
rate
sec
uri
ties
to
sel
l th
eir
ho
ldin
gs.
Org
aniz
ed s
tock
exc
han
ges
and
bo
nd
mar
kets
si
mp
lify
th
e tr
ansf
er o
f se
curi
ties
fro
m s
elle
rs t
o b
uye
rs.
Th
is “
ease
of
sale
” in
crea
ses
the
wil
lin
gnes
s o
f sa
vers
to
mak
e fi
nan
cial
inve
stm
ents
in c
orp
ora
te s
ecu
riti
es. B
esid
es,
corp
ora
tio
ns
hav
e ea
sier
acc
ess
to b
ank
cred
it t
han
do
oth
er t
ypes
of
bu
sin
ess
org
aniz
atio
ns.
Co
rpo
rati
on
s ar
eb
ette
r ri
sks
and
are
mo
re l
ikel
y to
bec
om
e p
rofi
tab
le c
li-
ents
of
ban
ks.
Co
r po
rati
on
s p
rovi
de
lim
ited
li
abil
ity
to
ow
ner
s y
(sto
ckh
old
ers)
, w
ho
ris
k o
nly
wh
at t
hey
pai
d f
or
thei
r st
ock
. Th
eir
per
son
al a
sset
s ar
e n
ot
at s
take
if t
he
corp
ora
-ti
on
def
ault
s o
n i
ts d
ebts
. C
red
ito
rs c
an s
ue
the
corp
ora
-ti
on
as
a le
gal
enti
ty b
ut
can
no
t su
e th
e o
wn
ers
of
the
corp
ora
tio
n a
s in
div
idu
als.
Bec
ause
of
thei
r ab
ilit
y to
att
ract
fin
anci
al c
apit
al, s
uc-
cess
ful
corp
ora
tio
ns
can
eas
ily
exp
and
th
e sc
op
e o
f th
eir
op
erat
ion
s an
d
real
ize
the
ben
efit
s o
f ex
pan
sio
n.
Fo
r ex
amp
le, t
hey
can
take
ad
van
tage
of m
ass-
pro
du
ctio
n te
ch-
no
logi
es a
nd
div
isio
n o
f la
bo
r. A
co
rpo
rati
on
can
hir
e sp
e-ci
alis
ts in
pro
du
ctio
n, a
cco
un
tin
g, a
nd
mar
keti
ng
fun
ctio
ns
and
th
us
imp
rove
eff
icie
ncy
.U
nli
ke s
ole
pro
pri
eto
rsh
ips
and
par
tner
ship
s, t
he
cor-
po
rati
on
has
a l
ife
ind
epen
den
t o
f it
s o
wn
ers
and
its
off
i-ce
rs.
As
a le
gal
enti
ty,
corp
ora
tio
ns
are
imm
ort
al.
Th
etr
ansf
er o
f co
rpo
rate
ow
ner
ship
th
rou
gh i
nh
erit
ance
or
Fig
ure
4.5
a sh
ow
s h
ow
th
e b
usi
nes
s p
op
ula
tio
n i
s d
istr
ib-
ute
d a
mo
ng
the
thre
e m
ajo
r fo
rms.
Ab
ou
t 72
per
cen
t o
f U
.S.
firm
s ar
e so
le p
rop
riet
ors
hip
s. T
hes
e fi
rms
are
son
um
ero
us
mai
nly
b
ecau
se
they
ar
e ea
sy
to
set
up
an
d
org
aniz
e. T
he
pro
pri
eto
r is
his
or
her
ow
n b
oss
an
d h
as s
ub
-st
anti
al fr
eed
om
of a
ctio
n. P
artn
ersh
ips
con
stit
ute
8 p
erce
nt
of
all
U.S
. b
usi
nes
s en
terp
rise
s. T
he
oth
er 2
0 p
erce
nt
are
corp
ora
tio
ns.
Bu
t as
Fig
ure
4.5
b s
ho
ws,
so
le p
rop
riet
ors
hip
s ac
cou
nt
for
on
ly
5 p
erce
nt
of
tota
l sa
les
(ou
tpu
t va
lue)
an
d
par
tner
ship
s o
nly
11
per
cen
t. T
he
rem
ain
der
—an
am
azin
g 84
per
cen
t—ac
cru
es t
o c
orp
ora
tio
ns.
Ad
va
nta
ge
s o
f C
orp
ora
tio
ns
Cer
tain
ad
van
tage
s o
f th
e co
rpo
rate
fo
rm
of
bu
sin
ess
ente
rpri
se h
ave
cata
pu
lted
it
into
a d
om
inan
t sa
les
and
p
rofi
t p
osi
tio
n in
th
e U
nit
ed S
tate
s. T
he
corp
ora
tio
n is
by
far
the
mo
st e
ffec
tive
fo
rm o
f b
usi
nes
s o
rgan
izat
ion
fo
rra
isin
g m
on
ey t
o f
inan
ce t
he
exp
ansi
on
of
its
faci
liti
es a
nd
cap
abil
itie
s. T
he
corp
ora
tio
n e
mp
loys
un
iqu
e m
eth
od
s o
f fi
nan
ce—
the
sell
ing
of
sto
cks
(eq
uit
y fi
nan
cin
g) a
nd
bo
nd
s(d
ebt
fin
anci
ng)
—th
at
enab
le
it
to
po
ol
the
fin
anci
alre
sou
rces
of
larg
e n
um
ber
s o
f p
eop
le.
FIGURE 4.5
Th
e b
usi
ne
ss p
op
ula
tio
n a
nd
sh
are
s o
f d
om
est
ico
utp
ut.
(a
) S
ole
pro
pri
eto
rsh
ips
do
min
ate
th
e b
usi
ne
ss p
op
ula
tio
n
nu
me
rica
lly,
bu
t (b
) co
rpo
rati
on
s a
cco
un
t fo
r a
bo
ut
84
pe
rce
nt
of
tota
l sa
les
(ou
tpu
t).
(a)
Per
centa
ge o
f fir
ms
Corp
ora
tions
20%
Par
tner
ship
s
8%
Sole
pro
pri
etors
hip
s
72%
(b)
Per
centa
ge o
f sa
les
Corp
ora
tions
84%
Sole
pro
pri
etors
hip
s 5%
Par
tner
ship
s 11%
Sourc
e:U
.S. C
ensu
s B
ure
au,www.census.gov.
Lat
est
dat
a.
CH
APT
ER
4
The U
.S. E
conom
y: P
riva
te a
nd P
ublic
Sec
tors
77
the
sale
of
sto
ck d
oes
no
t d
isru
pt
the
con
tin
uit
y o
f th
e co
r-p
ora
tio
n.
Co
rpo
rati
on
s h
ave
per
man
ence
th
at l
end
s it
self
to
lon
g-ra
nge
pla
nn
ing
and
gro
wth
. Th
is p
erm
anen
ce a
nd
gr
ow
th e
xpla
ins
wh
y vi
rtu
ally
all
th
e n
atio
n’s
larg
est
bu
si-
nes
s en
terp
rise
s ar
e co
rpo
rati
on
s.
Th
e P
rin
cip
al-
Ag
en
t P
rob
lem
M
any
of
the
wo
rld
’s co
rpo
rati
on
s ar
e ex
trem
ely
larg
e. I
n
2007
, 35
1 o
f th
e w
orl
d’s
larg
est
corp
ora
tio
ns
had
an
nu
alsa
les
of
mo
re t
han
$20
bil
lio
n; 1
21 f
irm
s h
ad s
ales
exc
eed
-in
g $5
0 b
illi
on
; an
d 3
0 fi
rms
had
sal
es g
reat
er t
han
$10
0b
illi
on
. U
.S.-
bas
ed W
al-M
art
alo
ne
had
sal
es o
f $3
51 b
il-
lio
n i
n 2
007.
Glo
bal
Per
spec
tive
4.1
lis
ts t
he
wo
rld
’s 10
larg
est
corp
ora
tio
ns,
by
ann
ual
sal
es.
Bu
t la
rge
size
cre
ates
a p
ote
nti
al p
rob
lem
. In
so
le p
ro-
pri
eto
rsh
ips
and
par
tner
ship
s, t
he
ow
ner
s o
f th
e re
al a
nd
fin
anci
al
asse
ts
of
the
firm
en
joy
dir
ect
con
tro
lo
f th
ose
ass
ets.
Bu
t o
wn
-er
ship
of
larg
e co
rpo
ra-
tio
ns
is s
pre
ad o
ver
ten
s o
r h
un
dre
ds
of
tho
usa
nd
s o
f st
ock
ho
lder
s. T
he
ow
ner
s o
f a
corp
ora
tio
n u
sual
ly d
o n
ot
man
age
it—
they
hir
e o
ther
s to
do
so
.T
hat
pra
ctic
e ca
n c
reat
e a
pri
nci
pal
-ag
en
t p
rob
lem
.T
he
prin
cipa
ls
are
th
e st
ock
ho
lder
s w
ho
ow
n t
he
corp
ora
-s
tio
n a
nd
wh
o h
ire
exec
uti
ves
as t
hei
r ag
ents
to r
un
th
es
bu
sin
ess
on
th
eir
beh
alf.
Bu
t th
e in
tere
sts
of
thes
e m
anag
-er
s (t
he
agen
ts)
and
th
e w
ish
es o
f th
e o
wn
ers
(th
e p
rin
ci-
pal
s) d
o n
ot
alw
ays
coin
cid
e. T
he
ow
ner
s ty
pic
ally
wan
t m
axim
um
co
mp
any
pro
fit
and
sto
ck p
rice
. H
ow
ever
, th
e ag
ent
may
wan
t th
e p
ow
er,
pre
stig
e, a
nd
pay
th
at o
ften
acco
mp
any
con
tro
l ove
r a
larg
e en
terp
rise
, in
dep
end
ent
of
its
pro
fita
bil
ity
and
sto
ck p
rice
.S
o a
co
nfl
ict
of
inte
rest
may
dev
elo
p.
Fo
r ex
amp
le,
exec
uti
ves
may
bu
ild
exp
ensi
ve o
ffic
e b
uil
din
gs,
enjo
y
O 4.1
Pri
nci
pal
-agent
pro
ble
m
ORIGIN OF THE IDEA
CO
NSID
ER
TH
IS .
. .
Unprincipled
Agents
In th
e 1990s
man
y
corp
ora
tions
ad-
dre
ssed
the
pri
nci
pal
-
agen
t pro
ble
m
by
pro
vidin
ga
subst
an-
tial
par
t of
exec
utive
f
pay
ei
ther
as
sh
ares
of
the
ffir
m’s s
tock
or
as s
tock
options. S
tock
options
are
con-
trac
ts th
at al
low
ex
ecutive
s or
oth
er ke
y em
plo
yees
to
buy
shar
es of th
eir
ef
mplo
yers’ st
ock
at fix
ed, l
ow
er p
rice
s w
hen
the
stock
pri
ces
rise
. The
inte
nt
was
to a
lign t
he
inte
rest
ofth
e ex
ec-
f
utive
s an
d o
ther
key
em
plo
yees
more
clo
sely
with t
hose
of
the
f
bro
ader
corp
ora
te o
wner
s. B
y purs
uin
g h
igh p
rofit
s an
d s
har
e
pri
ces, t
he
exec
utive
s w
ould
enhan
ce t
hei
r ow
n w
ealth a
s w
ell a
s
that
of al
l th
e st
ock
hold
ers.
f
T
his
“so
lution”
to t
he
pri
nci
pal
-agen
t pro
ble
mhad
an u
nex-
pec
ted n
egat
ive
side
effec
t. It
pro
ffm
pte
d a
few
uff
nsc
rupulo
us
exec
utive
s to
infla
te t
hei
r fir
ms’
shar
e pri
ces
by
hid
ing
cost
s,
ove
rsta
ting r
evenues
, engag
ing
in d
ece
ptive
tra
nsa
ctio
ns, a
nd, i
n
gener
al, ex
aggera
ting p
rofit
s. T
hes
e e
xecu
tive
s th
en s
old
lar
gre
quan
tities
of t
hei
r i
fnfla
ted s
tock
, mak
ing q
uic
k per
sonal
fort
uff
nes
.
Inso
me c
ases
, “in
dep
endent”
outs
ide a
uditin
gfir
ms
turn
ed o
ut
to b
e not
so indep
endent
bec
ause
they
held
val
uab
le c
onsu
ltin
g
contr
acts
with t
he fir
ms
bein
gau
dited
.
W
hen t
he
stock
-mar
ket
bubble
ofth
e la
te 1
990s
burs
t, f
man
y
inst
ance
s of
busi
fnes
sm
anip
ula
tions
andfr
audule
nt
acco
unting
wer
e ex
pose
d.
Seve
ral
exec
utive
s of
lar
fgre
U.S
. fir
ms
wer
e
indic
ted a
nd a
few
lar
ffgrefir
ms
colla
pse
d,
among t
hem
Enro
n
(ener
gry
trad
ing),
Worl
dC
om
(c
om
munic
atio
ns)
, an
dA
rthur
Ander
sen
(acc
ounting
and b
usi
nes
s co
nsu
ltin
g).
Genera
l st
ock
-
ho
lders
of th
ose
f
firm
s w
ere
left
ho
ldi
ffng
seve
rely
depre
ssed o
r
even w
ort
hle
ss s
tock
.
In 2
002 C
ongre
ss s
trength
ened the
law
s an
d p
enal
ties
agai
nst
exe
cutive
mis
conduct
. A
lso, co
rpora
tions
hav
e i
mpro
ved t
hei
r
acco
unting a
nd a
uditin
gpro
cedure
s. B
ut
seem
ingly
endle
ss r
ev-
elat
ions
of ex
ecutive
wro
fngdoin
gs
mak
e cl
ear
that
the
pri
nci
pal
-
agent
pro
ble
mis
not
an e
asy
pro
ble
mto
solv
e.
GLO
BA
L P
ER
SP
EC
TIV
E 4
.1
The World’s 10 Largest Corporations
Five
of
the
worl
df
’s 1
0 l
argrest
corp
ora
tions, b
ased
on d
olla
r
reve
nue
in2007, w
ere
hea
dquar
tere
d in t
he
United
Sta
tes.
Sourc
e: “
The
Wor
ld’s 10 La
rges
t Cor
por
ation
s,”
Fort
une
Glo
bal
500,
2007, www.
fortune.com. ©
2007 T
ime
Inc.
All
rights
res
erv
ed.
Wal
-Mar
t (U
.S.)
$351 b
illio
n
Exxo
nM
obil (
U.S
.) $
347 b
illio
n
Shell (
U.K
./N
eth
erl
ands)
$319 b
illio
n
BP (
U.K
.) $
274 b
illio
n
Genera
l M
oto
rs (
U.S
.) $
207 b
illio
n
Chevr
on (
U.S
.) $
201 b
illio
n
Dai
mle
rChry
sler
(Germ
any)
$190 b
illio
n
Conoco
Phill
ips
(U.S
.) $
172 b
illio
n
To
yota
(Ja
pan
) $
205 b
illio
n
Tota
l (F
rance
) $
168 b
illio
n
PA
RT
ON
E
Intr
oduct
ion t
o E
conom
ics
and t
he
Eco
nom
y7
8
entr
epre
neu
rial
res
ou
rces
. S
uch
sp
ecia
liza
tio
n p
rom
ote
s a
mo
re e
ffic
ien
t al
loca
tio
n o
f re
sou
rces
.L
ike
the
op
tim
al a
mo
un
t o
f an
y “g
oo
d,”
th
e o
pti
mal
am
ou
nt
of
regu
lati
on
is
that
at
wh
ich
th
e m
argi
nal
ben
efit
an
d m
argi
nal
co
st a
re e
qu
al. T
hu
s, t
her
e ca
n b
e ei
ther
to
oli
ttle
reg
ula
tio
n (
MB
exc
eed
s M
C)
or
too
mu
ch r
egu
lati
on
(MB
is
less
th
an M
C).
Th
e ta
sk i
s to
dec
ide
wis
ely
on
th
eri
ght
amo
un
t.
Ma
inta
inin
g C
om
pe
titi
on
C
om
pet
itio
n i
s th
e b
asic
reg
ula
tory
mec
han
ism
in
th
em
arke
t sy
stem
. It
is
the
forc
e th
at s
ub
ject
s p
rod
uce
rs a
nd
reso
urc
e su
pp
lier
s to
th
e d
icta
tes
of
con
sum
er s
ove
reig
nty
.W
ith
co
mp
etit
ion
, bu
yers
are
th
e b
oss
, th
e m
arke
t is
th
eir
agen
t, a
nd
bu
sin
esse
s ar
e th
eir
serv
ants
.It
is
a
dif
fere
nt
sto
ry
wh
ere
a si
ngl
e se
ller
—a
mo
no
po
ly—
con
tro
ls a
n i
nd
ust
ry.
By
con
tro
llin
g su
pp
ly,
a yy
mo
no
po
list
ca
n
char
ge
a h
igh
er-t
han
-co
mp
etit
ive
pri
ce.
Pro
du
cer
sove
rei g
nty
th
en s
up
pla
nts
co
nsu
mer
so
vere
ign
ty.
In t
he
Un
ited
Sta
tes,
go
vern
men
t h
as a
ttem
pte
d t
o c
on
tro
lm
on
op
oly
th
rou
gh r
egul
atio
nan
d t
hro
ugh
ant
itru
st.
A f
ew i
nd
ust
ries
are
nat
ura
l m
on
op
oli
es—
ind
ust
ries
in
wh
ich
tec
hn
olo
gy i
s su
ch t
hat
on
ly a
sin
gle
sell
er c
an
ach
ieve
th
e lo
wes
t p
oss
ible
co
sts.
In
so
me
case
s go
vern
-m
ent
has
all
ow
ed t
hes
e m
on
op
oli
es t
o e
xist
bu
t h
as a
lso
crea
ted
pu
bli
c co
mm
issi
on
s to
reg
ula
te t
hei
r p
rice
s an
d s
et
thei
r se
rvic
e st
and
ard
s. E
xam
ple
s o
f re
gula
ted
mon
opol
ies
are
som
e fi
rms
that
pro
vid
e lo
cal
elec
tric
ity,
tel
eph
on
e,
and
tra
nsp
ort
atio
n s
ervi
ces.
In
nea
rly
all
mar
kets
, h
ow
ever
, ef
fici
ent
pro
du
ctio
n
can
bes
t b
e at
tain
ed w
ith
a h
igh
deg
ree
of
com
pet
itio
n.
Th
e F
eder
al g
ove
rnm
ent
has
th
eref
ore
en
acte
d a
ser
ies
of
anti
tru
st (a
nti
mo
no
po
ly) l
aws,
beg
inn
ing
wit
h th
e S
her
man
A
ct o
f 18
90,
to p
roh
ibit
cer
tain
mo
no
po
ly a
bu
ses
and
, if
n
eces
sary
, b
reak
mo
no
po
list
s u
p i
nto
co
mp
etin
g fi
rms.
U
nd
er t
hes
e la
ws,
fo
r ex
amp
le,
in 2
000
Mic
roso
ft w
asfo
un
d g
uil
ty o
f m
on
op
oli
zin
g th
e m
arke
t fo
r o
per
atin
g sy
stem
s fo
r p
erso
nal
co
mp
ute
rs.
Rat
her
th
an b
reak
ing
up
Mic
roso
ft,
ho
wev
er,
the
gove
rnm
ent
imp
ose
d a
ser
ies
of
pro
hib
itio
ns
and
re
qu
irem
ents
th
at
coll
ecti
vely
li
mit
ed
Mic
roso
ft’s
abil
ity
to e
nga
ge i
n a
nti
com
pet
itiv
e ac
tio
ns.
Re
dis
trib
uti
ng
In
co
me
T
he
mar
ket
syst
em
is
imp
erso
nal
an
d
may
d
istr
ibu
tein
com
e m
ore
in
equ
itab
ly t
han
so
ciet
y d
esir
es.
It y
ield
s ve
ry la
rge
inco
mes
to
th
ose
wh
ose
lab
or,
by
virt
ue
of i
nh
er-
ent
abil
ity
and
acq
uir
ed e
du
cati
on
an
d s
kill
s, c
om
man
ds
hi g
h w
ages
. S
imil
arly
, th
ose
wh
o,
thro
ugh
har
d w
ork
or
inh
erit
ance
, po
sses
s va
luab
le c
apit
al a
nd
lan
d r
ecei
ve l
arge
pro
per
ty i
nco
mes
.
exce
ssiv
e p
erks
su
ch a
s co
rpo
rate
jet
s, a
nd
pay
to
o m
uch
to
acq
uir
e o
ther
co
rpo
rati
on
s. C
on
seq
uen
tly,
th
e fi
rm’s
co
sts
wil
l b
e ex
cess
ive
and
th
e ex
ecu
tive
s w
ill
fail
to
max
i-m
ize
pro
fit
and
th
e st
ock
pri
ce f
or
the
ow
ner
s. (
Key
Qu
est
ion
4)
• A
pla
nt
is a
ph
ysic
al e
stab
lish
men
t th
at c
on
trib
ute
s to
th
e p
rod
uct
ion
of
goo
ds
and
ser
vice
s; a
fir
m i
s a
bu
sin
ess
org
a-n
izat
ion
th
at o
wn
s an
d o
per
ates
pla
nts
; pla
nts
may
be
arra
nge
d h
ori
zon
tall
y, b
e ve
rtic
ally
in
tegr
ated
, an
d/o
r ta
keo
n a
co
ngl
om
erat
e fo
rm.
• T
he
thre
e b
asic
leg
al f
orm
s o
f b
usi
nes
s ar
e th
e so
le p
rop
ri-
eto
rsh
ip, t
he
par
tner
ship
, an
d t
he
corp
ora
tio
n. W
hil
e so
le
pro
pri
eto
rsh
ips
mak
e u
p 7
2 p
erce
nt
of
all
firm
s, c
orp
ora
-ti
on
s ac
cou
nt
for
84 p
erce
nt
of
tota
l sa
les.
• T
he
maj
or
adva
nta
ges
of
corp
ora
tio
ns
are
thei
r ab
ilit
y to
ra
ise
fin
anci
al c
apit
al, t
he
lim
ited
lia
bil
ity
they
bes
tow
on
ow
ner
s, a
nd
th
eir
con
tin
uin
g li
fe b
eyo
nd
th
e li
fe o
f th
eir
ow
ner
s an
d m
anag
ers.
• T
he
prin
cipa
l-ag
ent
prob
lem
is t
he
con
flic
t of
inte
rest
th
at
may
occ
ur w
hen
age
nts
(ex
ecut
ives
) pu
rsue
th
eir
own
obj
ec-
tive
s to
th
e de
trim
ent
of t
he
prin
cipa
ls’ (
stoc
khol
ders
’) g
oals
.
QU
ICK
RE
VIE
W 4
.2
Th
e P
ub
lic
Se
cto
r:
Go
ve
rnm
en
t’s
Ro
le
Th
e ec
on
om
ic a
ctiv
itie
s o
f th
e pu
blic
sec
tor
—
Fed
eral
, sta
te,
rran
d l
oca
l go
vern
men
t—ar
e ex
ten
sive
. W
e b
egin
by
dis
-cu
ssin
g th
e ec
on
om
ic f
un
ctio
ns
of
gove
rnm
ents
. W
hat
is
gove
rnm
ent’s
ro
le i
n t
he
eco
no
my?
Pro
vid
ing
th
e L
eg
al
Str
uc
ture
G
ove
rnm
ent
pro
vid
es t
he
lega
l fr
amew
ork
an
d t
he
ser-
vice
s n
eed
ed f
or
a m
arke
t ec
on
om
y to
op
erat
e ef
fect
ivel
y.T
he
lega
l fr
amew
ork
se
ts
the
lega
l st
atu
s o
f b
usi
nes
s en
terp
rise
s, e
nsu
res
the
righ
ts o
f p
riva
te o
wn
ersh
ip,
and
allo
ws
the
mak
ing
and
en
forc
emen
t o
f co
ntr
acts
. Go
vern
-m
ent
also
est
abli
shes
th
e le
gal
“ru
les
of
the
gam
e” t
hat
co
ntr
ol
rela
tio
nsh
ips
amo
ng
bu
sin
esse
s, r
eso
urc
e su
pp
li-
ers,
an
d c
on
sum
ers.
Dis
cret
e u
nit
s o
f go
vern
men
t re
fere
eec
on
om
ic r
elat
ion
ship
s, s
eek
ou
t fo
ul
pla
y, a
nd
im
po
sep
enal
ties
.G
ove
rnm
ent
inte
rven
tio
n is
pre
sum
ed t
o im
pro
ve t
he
allo
cati
on
of r
eso
urc
es. B
y su
pp
lyin
g a
med
ium
of e
xch
ange
, en
suri
ng
pro
du
ct q
ual
ity,
def
inin
g o
wn
ersh
ip r
igh
ts,
and
enfo
rcin
g co
ntr
acts
, th
e go
vern
men
t in
crea
ses
the
volu
me
and
saf
ety
of
exch
ange
. Th
is w
iden
s th
e m
arke
t an
d f
ost
ers
grea
ter
spec
iali
zati
on
in
th
e u
se o
f la
nd
, lab
or,
cap
ital
, an
d
CH
APT
ER
4
The U
.S. E
conom
y: P
riva
te a
nd P
ublic
Sec
tors
79
Bu
t m
any
oth
er m
emb
ers
of
soci
ety
hav
e le
ss p
rod
uc-
tive
ab
ilit
y, h
ave
rece
ived
on
ly m
od
est
amo
un
ts o
f ed
uca
-ti
on
an
d t
rain
ing,
an
d h
ave
accu
mu
late
d o
r in
her
ited
no
p
rop
erty
res
ou
rces
. M
ore
ove
r, s
om
e o
f th
e el
der
ly,
the
ph
ysic
ally
an
d m
enta
lly
dis
able
d,
and
th
e p
oo
rly
edu
cate
dea
rn s
mal
l in
com
es o
r, l
ike
the
un
emp
loye
d,
no
in
com
e at
al
l. T
hu
s so
ciet
y ch
oo
ses
to r
edis
trib
ute
a p
art
of
tota
l in
com
e th
rou
gh a
var
iety
of
gove
rnm
ent
po
lici
es a
nd
pro
-gr
ams.
Th
ey a
re:
•T
ran
sfer
paym
ents
sT
ran
sfer
pay
men
ts,ss f
or
exam
ple
, in
the
form
of
wel
fare
ch
ecks
an
d f
oo
d s
tam
ps,
pro
vid
ere
lief
to
th
e d
esti
tute
, th
e d
epen
den
t, t
he
dis
able
d,
and
old
er c
itiz
ens;
un
emp
loym
ent
com
pen
sati
on
pay
men
ts p
rovi
de
aid
to
th
e u
nem
plo
yed
. •
Mark
et i
nte
rven
tion
G
ove
rnm
ent
also
alt
ers
the
dis
trib
uti
on
of
inco
me
thro
ugh
mar
ket
inte
rven
tion
,th
at i
s, b
y ac
tin
g to
mo
dif
y th
e p
rice
s th
at a
re o
r w
ou
ld b
e es
tab
lish
ed b
y m
arke
t fo
rces
. Pro
vid
ing
farm
ers
wit
h a
bo
ve-m
arke
t p
rice
s fo
r th
eir
ou
tpu
t an
d r
equ
irin
g th
at f
irm
s p
ay m
inim
um
wag
es a
re
illu
stra
tio
ns
of
gove
rnm
ent
inte
rven
tio
ns
des
ign
ed
to r
aise
th
e in
com
e o
f sp
ecif
ic g
rou
ps.
•T
axati
on T
he
gove
rnm
ent
use
s th
e p
erso
nal
in
com
eta
x to
tak
e a
larg
er p
rop
ort
ion
of
the
inco
me
of
the
rich
th
an o
f th
e p
oo
r, t
hu
s n
arro
win
g th
e af
ter-
tax
inco
me
dif
fere
nce
bet
wee
n h
igh
-in
com
e an
d l
ow
-in
com
e ea
rner
s.
Th
e ex
ten
t to
w
hic
h
gove
rnm
ent
sho
uld
re
dis
trib
ute
tin
com
e is
su
bje
ct t
o l
ivel
y d
ebat
e. R
edis
trib
uti
on
in
volv
esb
oth
ben
efit
s an
d c
ost
s. T
he
pu
rpo
rted
ben
efit
s ar
e gr
eate
r “f
airn
ess”
or
“eco
no
mic
ju
stic
e”;
the
pu
rpo
rted
co
sts
are
red
uce
d i
nce
nti
ves
to w
ork
, sav
e, i
nve
st, a
nd
pro
du
ce, a
nd
th
eref
ore
a l
oss
of
tota
l o
utp
ut
and
in
com
e.
Re
all
oc
ati
ng
Re
sou
rce
s M
arke
t fa
ilu
reo
ccu
rs w
hen
th
e co
mp
etit
ive
mar
ket
syst
em(1
) p
rod
uce
s th
e “w
ron
g” a
mo
un
ts o
f ce
rtai
n g
oo
ds
and
se
rvic
es o
r (2
) fa
ils
to a
llo
cate
an
y re
sou
rces
wh
atso
ever
to
the
pro
du
ctio
n o
f ce
rtai
n g
oo
ds
and
ser
vice
s w
ho
se o
utp
ut
is e
con
om
ica l
ly j
ust
ifie
d.
Th
e fi
rst
typ
e o
f fa
ilu
re r
esu
lts
fro
m w
hat
eco
no
mis
ts c
all
exte
rnal
itie
s o
rs
spil
love
rs
and
th
e s
seco
nd
typ
e in
volv
es p
ubl
ic g
oods
.
Go
vern
men
t ca
n t
ake
acti
on
s to
try
to
ad
dre
ss b
oth
kin
ds
of
mar
ket
fail
ure
.
Externalities
Wh
en w
e sa
y th
at c
om
pet
itiv
e m
arke
tsau
tom
atic
ally
bri
ng
abo
ut
the
effi
cien
t u
se o
f res
ou
rces
, we
assu
me
that
all
th
e b
enef
its
and
co
sts
for
each
pro
du
ct a
refu
lly
refl
ecte
d i
n t
he
mar
ket
dem
and
an
d s
up
ply
cu
rves
. T
hat
is
no
t al
way
s th
e ca
se.
In s
om
e m
arke
ts c
erta
in b
en-
efit
s o
r co
sts
may
esc
ape
the
bu
yer
or
sell
er.
An
ext
ern
alit
yo
ccu
rs w
hen
so
me
of
the
cost
s o
r th
ey
ben
efit
s o
f a
goo
d a
re p
asse
d o
n t
o o
r “s
pil
l o
ver
to”
som
e-o
ne
oth
er th
an th
e im
me-
dia
te b
uye
r o
r se
ller
. Su
ch
spil
love
rs a
re c
alle
d e
xter
-n
alit
ies
bec
ause
th
ey a
re
ben
efit
s o
r co
sts
that
ac
cru
e to
so
me
thir
d p
arty
th
at i
s ex
tern
alto
th
e m
arke
t l
tran
sact
ion
.
Neg
ati
ve
Ex
tern
ali
ties
P
rod
uct
ion
or
con
sum
pti
on
co
sts
infl
icte
d o
n a
th
ird
par
ty w
ith
ou
t co
mp
ensa
tio
n a
re
call
ed n
eg
ativ
e e
xtern
alit
ies .
En
viro
nm
enta
l p
oll
uti
on
is
an e
xam
ple
. W
hen
a c
hem
ical
man
ufa
ctu
rer
or
a m
eat-
pac
kin
g p
lan
t d
um
ps
its
was
tes
into
a l
ake
or
rive
r, s
wim
-m
ers,
fis
her
s, a
nd
bo
ater
s—an
d p
erh
aps
tho
se w
ho
dri
nk
the
wat
er—
suff
er e
xter
nal
co
sts.
Wh
en a
pet
role
um
ref
in-
ery
po
llu
tes
the
air
wit
h s
mo
ke o
r a
pap
er m
ill
crea
tes
ob
-n
oxi
ou
s o
do
rs,
the
com
mu
nit
y ex
per
ien
ces
exte
rnal
co
sts
for
wh
ich
it
is n
ot
com
pen
sate
d.
Wh
at
are
the
eco
no
mic
ef
fect
s?
Rec
all
that
co
sts
det
erm
ine
the
po
siti
on
of
the
firm
’s su
pp
ly c
urv
e. W
hen
a
firm
avo
ids
som
e co
sts
by
po
llu
tin
g, i
ts s
up
ply
cu
rve
lies
fa
rth
er t
o t
he
righ
t th
an i
t d
oes
wh
en t
he
firm
bea
rs t
he
full
co
sts
of
pro
du
ctio
n.
As
a re
sult
, th
e p
rice
of
the
pro
d-
uct
is
too
lo
w a
nd
th
e o
utp
ut
of
the
pro
du
ct i
s to
o l
arge
to
ac
hie
ve a
llo
cati
ve e
ffic
ien
cy. A
mar
ket
fail
ure
occ
urs
in t
he
form
of
an o
vera
llo
cati
on
of
reso
urc
es t
o t
he
pro
du
ctio
n o
f th
e go
od
.
Co
rrec
tin
g f
or
Neg
ati
ve
Exte
rna
liti
esS
om
e ex
ter-
nal
itie
s ge
t re
solv
ed v
ia p
riva
te n
ego
tiat
ion
s b
etw
een
th
ose
cr
eati
ng
the
exte
rnal
itie
s an
d t
ho
se a
ffec
ted
by
them
. B
ut
wh
en t
he
exte
rnal
itie
s ar
e w
ides
pre
ad a
nd
neg
oti
atio
n
bet
wee
n p
arti
es i
s u
nre
alis
tic,
go
vern
men
t ca
n p
lay
an
imp
ort
ant
role
. F
or
exam
ple
, it
can
do
tw
o t
hin
gs
toco
rrec
t th
e o
vera
llo
cati
on
of
reso
urc
es a
sso
ciat
ed w
ith
neg
ativ
e ex
tern
alit
ies.
Bo
th s
olu
tio
ns
are
des
ign
ed t
oin
tern
a liz
e ex
tern
al c
ost
s, t
hat
is,
to
mak
e th
e o
ffen
din
g fi
rm p
ay t
he
cost
s ra
ther
th
an s
hif
t th
em t
o o
ther
s:
•L
egis
lati
on
In c
ases
of
air
and
wat
er p
oll
uti
on
,th
e m
ost
dir
ect
acti
on
is
legi
slat
ion
pro
hib
itin
g o
r li
mit
ing
the
po
llu
tio
n. S
uch
leg
isla
tio
n f
orc
esp
ote
nti
al p
oll
ute
rs t
o p
ay f
or
the
pro
per
dis
po
sal
of
ind
ust
rial
was
tes—
her
e, b
y in
stal
lin
g sm
oke
-ab
atem
ent
equ
ipm
ent
or
wat
er-p
uri
fica
tio
n f
acil
itie
s.T
he
idea
is
to f
orc
e p
ote
nti
al o
ffen
der
s, u
nd
er t
he
thre
at o
f le
gal
acti
on
, to
bea
r al
l th
e co
sts
asso
ciat
ed
lw
ith
pro
du
ctio
n.
•S
peci
fic
taxes
A l
ess
dir
ect
acti
on
is
bas
ed o
n t
he
fact
s
that
tax
es a
re a
co
st a
nd
th
eref
ore
a d
eter
min
ant
of
a
O 4.2
Externalities
OR
IGIN
OF
TH
E I
DE
A
PA
RT
ON
E
Introductio
n to Eco
nomics and the Eco
nomy
80
pro
vid
e su
bst
anti
al p
ort
ion
s o
f th
e b
ud
gets
of
pu
bli
c co
lleg
es a
nd
un
iver
siti
es. S
uch
su
bsi
die
s lo
wer
th
eco
sts
of
pro
du
cin
g h
igh
er e
du
cati
on
an
d i
ncr
ease
its
su
pp
ly. P
ub
licl
y su
bsi
diz
ed i
mm
un
izat
ion
pro
gram
s,h
osp
ital
s, a
nd
med
ical
res
earc
h a
re o
ther
exa
mp
les.
•P
rovi
de
goo
ds
via g
over
nm
ent
A
th
ird
po
licy
op
tio
nt
may
be
app
rop
riat
e w
her
e p
osi
tive
ext
ern
alit
ies
are
extr
emel
y la
rge:
Go
vern
men
t m
ay f
inan
ce o
r, i
nth
e ex
trem
e, o
wn
an
d o
per
ate
the
ind
ust
ry t
hat
is
invo
lved
. Exa
mp
les
are
the
U.S
. Po
stal
Ser
vice
an
d F
eder
al a
ir t
raff
ic c
on
tro
l sy
stem
s.
Public Goods and Services
Cer
tain
go
od
s ca
lled
priv
ate
good
sar
e p
rod
uce
d t
hro
ugh
th
e co
mp
etit
ive
mar
-s
ket
syst
em.
Exa
mp
les
are
the
wid
e va
riet
y o
f it
ems
sold
in
st
ore
s. P
riva
te g
oo
ds
hav
e tw
o c
har
acte
rist
ics—
riva
lry
and
excl
uda
bili
ty.
“Riv
alry
” m
ean
s th
at w
hen
on
e p
erso
n b
uys
an
d c
on
sum
es a
pro
du
ct,
it i
s n
ot
avai
lab
le f
or
pu
rch
ase
and
co
nsu
mp
tio
n b
y an
oth
er p
erso
n. W
hat
Jo
an g
ets,
Jan
e ca
nn
ot
hav
e. E
xclu
dabi
lity
m
ean
s th
at b
uye
rs w
ho
are
wil
l-in
g an
d a
ble
to
pay
th
e m
arke
t p
rice
fo
r th
e p
rod
uct
ob
tain
it
s b
enef
its,
bu
t th
ose
un
able
or
un
wil
lin
g to
pay
th
at p
rice
do
no
t. T
his
ch
arac
teri
stic
en
able
s p
rofi
tab
le p
rod
uct
ion
b
y a
pri
vate
fir
m.
Cer
tain
oth
er g
oo
ds
and
ser
vice
s ca
lled
pu
bli
c g
oo
ds
hav
e th
e o
pp
osi
te c
har
acte
rist
ics—
non
riva
lry
and
non
ex-
clu
dabi
lity
. Eve
ryo
ne
can
sim
ult
aneo
usl
y o
bta
in t
he
ben
efit
fr
om
a p
ub
lic
goo
d s
uch
as
a gl
ob
al p
osi
tio
nin
g sy
stem
, n
atio
nal
def
ense
, st
reet
lig
hti
ng,
an
d e
nvi
ron
men
tal
pro
-te
ctio
n.
On
e p
erso
n’s
ben
efit
do
es n
ot
red
uce
th
e b
enef
it
avai
lab
le t
o o
ther
s. M
ore
im
po
rtan
t, t
her
e is
no
eff
ecti
ve
way
of
excl
ud
ing
ind
ivid
ual
s fr
om
th
e b
enef
it o
f th
e go
od
o
nce
it
com
es i
nto
exi
sten
ce. T
he
inab
ilit
y to
exc
lud
e cr
e-at
es a
fre
e-r
ider
pro
ble
m ,
in w
hic
h p
eop
le c
an r
ecei
ve
ben
efit
s fr
om
a p
ub
lic
goo
d w
ith
ou
t h
avin
g to
pay
fo
r it
. A
s a
resu
lt,
goo
ds
and
ser
vice
s su
bje
ct t
o f
ree
rid
ing
wil
l ty
pic
ally
be
un
pro
fita
ble
fo
r an
y p
riva
te f
irm
th
at d
ecid
es
to p
rod
uce
an
d s
ell
them
. A
n e
xam
ple
of
a p
ub
lic
go
od
is
the
war
on
ter
rori
sm.
Th
is p
ub
lic
go
od
is
tho
ug
ht
to b
e ec
on
om
ical
ly j
ust
ifie
d
by
the
maj
ori
ty o
f A
mer
ican
s b
ecau
se t
he
ben
efit
s ar
e p
erce
ived
as
exce
edin
g t
he
cost
s. O
nce
th
e w
ar e
ffo
rts
are
un
der
take
n,
ho
wev
er,
the
ben
efit
s ac
cru
e to
al
lA
mer
ican
s (n
on
riva
lry)
. A
nd
th
ere
is n
o p
ract
ical
way
to
ex
c lu
de
any
Am
eric
an
fro
m
rece
ivin
g
tho
se
ben
efit
s(n
on
excl
ud
abil
ity)
.N
o p
riva
te f
irm
wil
l u
nd
erta
ke t
he
war
on
ter
rori
sm
bec
ause
th
e b
enef
its
can
no
t b
e p
rofi
tab
ly s
old
(d
ue
to t
he
free
-rid
er p
rob
lem
). S
o h
ere
we
hav
e a
serv
ice
that
yie
lds
sub
stan
tial
ben
efit
s b
ut
to w
hic
h t
he
mar
ket
syst
em w
ill
no
t al
loca
te s
uff
icie
nt
reso
urc
es.
Lik
e n
atio
nal
def
ense
in
firm
’s su
pp
ly c
urv
e. G
ove
rnm
ent
mig
ht
levy
a s
peci
fic
ta
x—th
at i
s, a
tax
co
nfi
ned
to
a p
arti
cula
r p
rod
uct
—xx
on e
ach
un
it o
f th
e po
lluti
ng
firm
’s ou
tput
. Th
e am
oun
t o
f th
is t
ax w
ou
ld r
ou
ghly
eq
ual
th
e es
tim
ated
do
llar
va
lue
of
the
neg
ativ
e ex
tern
alit
y ar
isin
g fr
om
th
ep
rod
uct
ion
of
each
un
it o
f o
utp
ut.
Th
rou
gh t
his
tax
,go
vern
men
t w
ou
ld i
mp
ose
a c
ost
on
th
e o
ffen
din
g fi
rm e
qu
ival
ent
to t
he
spil
love
r co
st t
he
firm
is
avo
idin
g. T
his
wo
uld
sh
ift
the
firm
’s su
pp
ly c
urv
e to
the
left
, red
uci
ng
equ
ilib
riu
m o
utp
ut
and
eli
min
atin
g th
e o
vera
llo
cati
on
of
reso
urc
es.
Po
siti
ve
Ex
tern
ali
ties
So
met
imes
ext
ern
alit
ies
app
ear
as b
enef
its
to o
ther
pro
du
cers
or
con
sum
ers.
Th
ese
un
-co
mp
ensa
ted
sp
illo
vers
acc
ruin
g t
o t
hir
d p
arti
es o
r th
eco
mm
un
ity
at l
arg
e ar
e ca
lled
po
siti
ve e
xtern
alit
ies .
Imm
un
izat
ion
aga
inst
mea
sles
an
d p
oli
o r
esu
lts
in d
irec
t b
enef
its
to t
he
imm
edia
te c
on
sum
er o
f th
ose
vac
cin
es. B
ut
it a
lso
res
ult
s in
wid
esp
read
su
bst
anti
al e
xter
nal
ben
efit
s to
the
enti
re c
om
mu
nit
y.
Ed
uca
tio
n is
an
oth
er e
xam
ple
of
po
siti
ve e
xter
nal
itie
s.E
du
cati
on
ben
efit
s in
div
idu
al c
on
sum
ers:
Bet
ter-
edu
cate
dp
eop
le g
ener
ally
ach
ieve
hig
her
in
com
es t
han
les
s-w
ell-
edu
cate
d p
eop
le.
Bu
t ed
uca
tio
n a
lso
pro
vid
es b
enef
its
toso
ciet
y, i
n t
he
form
of
a m
ore
ver
sati
le a
nd
mo
re p
rod
uc-
tive
lab
or
forc
e, o
n t
he
on
e h
and
, an
d s
mal
ler
ou
tlay
s fo
rcr
ime
pre
ven
tio
n, l
aw e
nfo
rcem
ent,
an
d w
elfa
re p
rogr
ams,
on
th
e o
ther
. E
xter
nal
ben
efit
s m
ean
th
at t
he
mar
ket
dem
and
cu
rve,
w
hic
h r
efle
cts
on
ly p
riva
te b
enef
its,
un
der
stat
es t
ota
l b
en-
efit
s. T
he
dem
and
cu
rve
for
the
pro
du
ct l
ies
fart
her
to
th
ele
ft t
han
it
wo
uld
if
the
mar
ket
too
k al
l b
enef
its
into
acco
un
t. A
s a
resu
lt,
a sm
alle
r am
ou
nt
of
the
pro
du
ct w
ill
be
pro
du
ced
, or,
alt
ern
ativ
ely,
th
ere
wil
l b
e an
un
dera
lloc
a-ti
ono
f re
sou
rces
to
th
e p
rod
uct
—ag
ain
a m
arke
t fa
ilu
re.
Co
rrec
tin
g f
or
Po
siti
ve
Ex
tern
ali
ties
H
ow
mig
ht
go
vern
men
t d
eal
wit
h t
he
un
der
rall
oca
tio
n o
f re
sou
rces
re
sult
ing
fro
m p
osi
tive
ext
ern
alit
ies?
Th
e an
swer
is
eith
erto
su
bsi
diz
e co
nsu
mer
s (t
o i
ncr
ease
dem
and
), t
o s
ub
sid
ize
pro
du
cers
(to
in
crea
se s
up
ply
), o
r, i
n t
he
extr
eme,
to
hav
e go
vern
men
t p
rod
uce
th
e p
rod
uct
:
•Su
bsid
ize
con
sum
ers
To
co
rrec
t th
e u
nd
eral
loca
tio
n
so
f re
sou
rces
to
hig
her
ed
uca
tio
n, t
he
U.S
. go
vern
men
t p
rovi
des
low
-in
tere
st lo
ans
to s
tud
ents
so
th
at t
hey
can
af
ford
mo
re e
du
cati
on
. Th
ose
loan
s in
crea
se t
he
dem
and
fo
r h
igh
er e
du
cati
on
.•
Su
bsid
ize
supp
lier
s In
so
me
case
s go
vern
men
t fi
nd
ss
it m
ore
co
nve
nie
nt
and
ad
min
istr
ativ
ely
sim
ple
r to
corr
ect
an u
nd
eral
loca
tio
n b
y su
bsi
diz
ing
sup
pli
ers.
Fo
r ex
amp
le, i
n h
igh
er e
du
cati
on
, sta
te g
ove
rnm
ents
CH
APT
ER
4
The U.S. Eco
nomy: Private a
nd Public Sectors
81
gen
eral
, th
e p
urs
uit
of
the
war
on
ter
rori
sm i
s a
pu
bli
cgo
od
. S
oci
ety
sign
als
its
des
ire
for
such
go
od
s b
y vo
tin
g fo
r p
arti
cula
r p
oli
tica
l can
did
ates
wh
o s
up
po
rt t
hei
r p
rovi
-si
on
. B
ecau
se o
f th
e fr
ee-r
ider
pro
ble
m,
the
pu
bli
c se
cto
rp
rovi
des
th
ese
goo
ds
and
fin
ance
s th
em t
hro
ugh
co
mp
ul-
sory
ch
arge
s in
th
e fo
rm o
f ta
xes.
Quasi-Public Goods
Go
vern
men
t p
rovi
des
man
y go
od
s th
at f
it t
he
eco
no
mis
t’s d
efin
itio
n o
f a
pu
bli
c go
od
.H
ow
ever
, it
als
o p
rovi
des
oth
er g
oo
ds
and
ser
vice
s th
at
cou
ld b
e p
rod
uce
d a
nd
del
iver
ed i
n s
uch
a w
ay t
hat
exc
lu-
sio
n w
ou
ld b
e p
oss
ible
. S
uch
go
od
s, c
alle
d q
uas
i-p
ub
lic
go
od
s, i
ncl
ud
e ed
uca
tio
n,
stre
ets
and
hig
hw
ays,
po
lice
an
d
fire
p
rote
ctio
n,
lib
rari
es
and
m
use
um
s,
pre
ven
tive
m
edic
ine,
an
d s
ewag
e d
isp
osa
l. T
hey
co
uld
all
be
pri
ced
and
pro
vid
ed b
y p
riva
te f
irm
s th
rou
gh t
he
mar
ket
syst
em.
Bu
t, a
s w
e n
ote
d e
arli
er,
bec
ause
th
ey a
ll h
ave
sub
stan
tial
p
osi
tive
ext
ern
alit
ies,
th
ey w
ou
ld b
e u
nd
erp
rod
uce
d b
y th
e m
arke
t sy
stem
. Th
eref
ore
, go
vern
men
t o
ften
pro
vid
es
them
to
avo
id t
he
un
der
allo
cati
on
of
reso
urc
es t
hat
wo
uld
o
ther
wis
e o
ccu
r.
The Reallocation Process
Ho
w
are
reso
urc
esre
allo
cate
d
fro
m
the
pro
du
ctio
n
of
pri
vate
go
od
s to
th
e p
rod
uct
ion
of
pu
bli
c an
d q
uas
i-p
ub
lic
goo
ds?
If
the
reso
urc
es o
f th
e ec
on
om
y ar
e fu
lly
emp
loye
d, g
ove
rnm
ent
mu
st f
ree
up
res
ou
rces
fro
m t
he
pro
du
ctio
n o
f p
riva
tego
od
s an
d m
ake
them
ava
ilab
le f
or
pro
du
cin
g p
ub
lic
and
q
uas
i-p
ub
lic
goo
ds.
It
do
es s
o b
y re
du
cin
g p
riva
te d
eman
dfo
r th
em.
An
d i
t d
oes
th
at b
y le
vyin
g ta
xes
on
ho
use
ho
lds
and
bu
sin
esse
s, t
akin
g so
me
of
thei
r in
com
e o
ut
of
the
cir-
cula
r fl
ow
. Wit
h l
ow
er i
nco
mes
an
d h
ence
les
s p
urc
has
ing
po
wer
, h
ou
seh
old
s an
d b
usi
nes
ses
mu
st c
urt
ail
thei
r co
n-
sum
pti
on
an
d i
nve
stm
ent
spen
din
g. A
s a
resu
lt,
the
pri
-va
te d
eman
d f
or
goo
ds
and
ser
vice
s d
ecli
nes
, as
do
es t
he
pri
vate
dem
and
fo
r re
sou
rces
. S
o b
y d
iver
tin
g p
urc
has
ing
po
wer
fro
m p
riva
te s
pen
der
s to
go
vern
men
t, t
axes
rem
ove
re
sou
rces
fro
m p
riva
te u
se.
Go
vern
men
t th
en s
pen
ds
the
tax
pro
ceed
s to
pro
vid
ep
ub
lic
and
q
uas
i-p
ub
lic
goo
ds
and
se
rvic
es.
Tax
atio
n
rele
ases
res
ou
rces
fro
m t
he
pro
du
ctio
n o
f p
riva
te c
on
-su
mer
go
od
s (f
oo
d,
clo
thin
g, t
elev
isio
n s
ets)
an
d p
riva
tein
vest
men
t go
od
s (p
rin
tin
g p
ress
es,
bo
xcar
s, w
areh
ou
ses)
. G
ove
rnm
ent
shif
ts t
ho
se r
eso
urc
es t
o t
he
pro
du
ctio
n o
f p
ub
lic
and
qu
asi-
pu
bli
c go
od
s (p
ost
off
ices
, su
bm
arin
es,
par
ks),
ch
angi
ng
the
com
po
siti
on
of
the
eco
no
my’
s to
tal
ou
tpu
t. (
Key
Qu
est
ion
s 9
an
d 1
0)
Pro
mo
tin
g S
tab
ilit
y
Mac
roec
on
om
ic s
tab
ilit
y is
sai
d t
o e
xist
wh
en a
n e
con
o-
my’
s o
utp
ut
mat
ches
it
s p
rod
uct
ion
ca
pac
ity,
it
s la
bo
r
reso
urc
es a
re f
ull
y em
plo
yed
, an
d i
nfl
atio
n i
s lo
w a
nd
sta
-b
le. (
Infl
atio
n is
a g
ener
al in
crea
se in
th
e le
vel o
f pri
ces.
) In
su
ch c
ircu
mst
ance
s, t
he
eco
no
my’
s to
tal s
pen
din
g m
atch
esit
s p
rod
uct
ion
cap
acit
y. G
ove
rnm
ent
and
th
e n
atio
n’s
cen
-tr
al b
ank
(th
e F
eder
al R
eser
ve i
n t
he
Un
ited
Sta
tes)
pro
-m
ote
fu
ll e
mp
loym
ent
and
pri
ce s
tab
ilit
y th
rou
gh p
rud
ent
fisc
al p
olic
y (g
ove
rnm
ent
taxi
ng
and
sp
end
ing
po
licy
) an
d
CO
NSID
ER
TH
IS .
. .
Street
Entertainers
Street entertai
n-
ers are ofte
ffn
fou
ffnd
intourist areas o
f
major cities. Some
entertai
ners
are
highly creative and
tale
nted;
others
“need m
ore prac-
tice.” But, re
gardless o
f tale
fnt level, these entertai
ners illuminate
the co
ncepts o
ffree riders and public
goods.
Most street entertai
ners have a hard time ear
nin
g a livin
g
from
their activities (u
nless eve
nt orgranizers pay them) because
they have no w
ay o
fexcludi
fng
nonpayers fro
m the benefits of
their e
ntertai
nment. They essentially are providin
gpublic, not
private, goods and
must rely o
nvolu
ntary pay
ments.
The result is a si
gnifica
nt
free-rider proble
m. O
nly a
few i
ffn
the audie
nce put
money in the container or instru
ment case,
and
many who do so contribute o
nly toke
n a
mounts. The rest
are
free riders who obtain the benefits of the street e
fntertai
n-
ment and retain their m
oney
for purchases that
ffthey
iy
nitiate.
Street entertai
ners are acutely aw
are o
fthe
ffree-rider
proble
m, a
nd so
me have
fou
ffnd creative w
ays to lessen it. Fo
r
exam
ple, so
me e
ntertai
ners i
nvolve the audie
nce directly i
n
the act. This usually creates a
greater se
nse o
f audie
fnce willin
g-
ness (or obligatio
n) to co
ntribute
mo
ney at the e
nd o
f the
f
perfor
ffmance.
“Pay
for per
fffor
ffmance” is a
nother creative approach to less-
enin
gthe free-rider proble
m. A
good exam
ple is the street
entertai
ner pai
nted up to look like a statue. W
henpeople drop
coins into the container, the “statue”
makes a slight
move
ment.
The
greater the contributions, the greater the
move
ment. But
these human
“statues” still
face a
fffree-rider proble
m: N
onpay-
ers also
get to e
njoy the acts.
Finally, because talented street entertai
ners create a
fes-
ff
tive street enviro
nment, cities or retailers so
meti
mes hire
them
to perfor
ffm. The “
free e
ntertai
nment” attracts crowds o
f
shoppers, who buy
goods
fro
mnearby retailers. In
these
instances the cities or retailers use tax reve
nue or co
mmer-
cial funds to pay the e
ntertai
ners, i
n the for
ffmer case validatin
g
them as public
goods.
PA
RT
ON
E
Introductio
n to Eco
nomics and the Eco
nomy
82
blo
cked
by
the
very
par
ties
th
at a
re p
rod
uci
ng
the
spil
l-o
vers
. In
sh
ort
, th
e ec
on
om
ic r
ole
of g
ove
rnm
ent,
alt
ho
ugh
crit
ical
to
a w
ell-
fun
ctio
nin
g ec
on
om
y, i
s n
ot
alw
ays
per
-fe
ctly
car
ried
ou
t.
mon
etar
y po
licy
(c
entr
al
ban
k in
tere
st
rate
p
oli
cy).
B
ut
som
etim
es u
nex
pec
ted
sh
ock
s o
ccu
r to
th
e ec
on
om
y th
at
cau
se t
ota
l sp
end
ing
eith
er t
o f
all
far
bel
ow
pro
du
ctio
n
cap
acit
y o
r to
su
rge
way
ab
ove
it,
res
ult
ing
in w
ides
pre
adu
nem
plo
ymen
t o
r in
flat
ion
. G
ove
rnm
ent
may
tr
y to
add
ress
th
ese
pro
ble
ms
by
alte
rin
g it
s fi
scal
po
licy
or
mo
n-
etar
y p
oli
cy.
•U
nem
ploy
men
t W
hen
pri
vate
sec
tor
spen
din
g is
to
ot
low
, res
ult
ing
in u
nem
plo
ymen
t, g
ove
rnm
ent
may
try
to
incr
ease
to
tal s
pen
din
g (p
riva
te +
pu
bli
c) b
y ra
isin
g it
s o
wn
sp
end
ing
or
by
low
erin
g ta
x ra
tes
to e
nco
ura
gegr
eate
r p
riva
te s
pen
din
g. A
lso
, th
e n
atio
n’s
cen
tral
b
ank
may
tak
e m
on
etar
y ac
tio
ns
to lo
wer
inte
rest
ra
tes,
th
ereb
y en
cou
ragi
ng
mo
re p
riva
te b
orr
ow
ing
and
sp
end
ing.
•
Infl
ati
on
Infl
atio
n i
s a
gen
eral
in
crea
se i
n t
he
leve
l o
f p
rice
s. P
rice
s o
f go
od
s an
d s
ervi
ces
rise
wh
en t
he
amo
un
t o
f sp
end
ing
in t
he
eco
no
my
exp
and
s m
ore
rap
idly
th
an t
he
sup
ply
of
goo
ds
and
ser
vice
s. T
his
can
hap
pen
wh
en t
he
nat
ion
’s ce
ntr
al b
ank
allo
ws
inte
rest
rat
es t
o r
emai
n t
oo
lo
w f
or
the
eco
no
mic
ci
rcu
mst
ance
s. I
n s
uch
sit
uat
ion
s, t
he
cen
tral
ban
k ca
n a
ct t
o lo
wer
infl
atio
n b
y in
crea
sin
g th
e in
tere
st
rate
so
as
to d
amp
en p
riva
te b
orr
ow
ing
and
sp
end
ing.
Th
e go
vern
men
t m
ay a
lso
try
to
red
uce
to
tal s
pen
din
g b
y cu
ttin
g it
s o
wn
exp
end
itu
res
or
bo
ost
ing
tax
rate
sto
red
uce
pri
vate
sp
end
ing.
Go
ve
rnm
en
t’s
Ro
le:
A Q
ua
lifi
ca
tio
n
Go
vern
men
t d
oes
no
t h
ave
an e
asy
task
in p
erfo
rmin
g th
eaf
ore
men
tio
ne d
ec
on
om
ic
fun
ctio
ns.
In
a
dem
ocr
acy,
gove
rnm
ent
un
der
take
s it
s ec
on
om
ic r
ole
in
th
e co
nte
xt
of
po
liti
cs.
To
ser
ve t
he
pu
bli
c, p
oli
tici
ans
nee
d t
o g
et
elec
ted
. T
o s
tay
elec
ted
, o
ffic
ials
(p
resi
den
ts,
sen
ato
rs,
rep
rese
nta
tive
s, m
ayo
rs,
cou
nci
l m
emb
ers,
sch
oo
l b
oar
dm
emb
ers)
nee
d t
o s
atis
fy t
hei
r p
arti
cula
r co
nst
itu
enci
es.
At
bes
t, t
he
po
liti
cal
real
itie
s co
mp
lica
te g
ove
rnm
ent’s
ro
le i
n t
he
eco
no
my;
at
wo
rst,
th
ey p
rod
uce
un
des
irab
leec
on
om
ic o
utc
om
es.
In t
he
po
liti
cal
con
text
, o
verr
egu
lati
on
can
occ
ur
in
som
e ca
ses;
un
der
regu
lati
on
, in
oth
ers.
In
com
e ca
n b
e re
dis
trib
ute
d t
o s
uch
an
ext
ent
that
in
cen
tive
s to
wo
rk,
save
, an
d in
vest
su
ffer
. So
me
pu
bli
c go
od
s an
d q
uas
i-p
ub
lic
goo
ds
can
be
pro
du
ced
no
t b
ecau
se t
hei
r b
enef
its
exce
edth
eir
cost
s b
ut
bec
ause
th
eir
ben
efit
s ac
cru
e to
fi
rms
loca
ted
in
st
ates
se
rved
b
y p
ow
erfu
l el
ecte
d
off
icia
ls.
Inef
fici
ency
can
eas
ily
cree
p i
nto
go
vern
men
t ac
tivi
ties
b
ecau
se o
f th
e la
ck o
f a
pro
fit
ince
nti
ve t
o h
old
do
wn
co
sts.
P
oli
cies
to
co
rrec
t n
egat
ive
exte
rnal
itie
s ca
n b
e p
oli
tica
lly
• G
ove
rnm
ent
enh
ance
s th
e o
per
atio
n o
f th
e m
arke
t sy
stem
b
y p
rovi
din
g an
ap
pro
pri
ate
lega
l fo
un
dat
ion
an
d p
rom
ot-
ing
com
pet
itio
n.
• T
ran
sfer
pay
men
ts, d
irec
t m
arke
t in
terv
enti
on
, an
d t
axat
ion
ar
e am
on
g th
e w
ays
in w
hic
h g
ove
rnm
ent
can
les
sen
in
com
e in
equ
alit
y.
• G
ove
rnm
ent
can
co
rrec
t fo
r th
e o
vera
llo
cati
on
of
reso
urc
es a
sso
ciat
ed w
ith
neg
ativ
e ex
tern
alit
ies
thro
ugh
lelegigi
slslatat
ioionn
or
or
t taxax
eses;; i
titc canan
o offff
sesett
ththee
un
un
de
der
arallll
oc
oca
tatioio
nn o
fo
f re
sou
rces
ass
oci
ated
wit
h p
osi
tive
ext
ern
alit
ies
by
gran
tin
g go
vern
men
t su
bsi
die
s.
• G
ove
rnm
ent
pro
vid
es c
erta
in p
ub
lic
goo
ds
for
wh
ich
th
ere
is n
on
riva
lry
in c
on
sum
pti
on
an
d n
on
excl
ud
abil
ity
of
ben
-ef
its;
go
vern
men
t al
so p
rovi
des
man
y q
uas
i-p
ub
lic
goo
ds
bec
ause
of
thei
r la
rge
exte
rnal
ben
efit
s.
• A
nat
ion
’s go
vern
men
t an
d c
entr
al b
ank
pro
mo
te e
con
om
ic
stab
ilit
y b
y en
gagi
ng
in p
rud
ent
fisc
al a
nd
mo
net
ary
po
lici
es.
QU
ICK
RE
VIE
W 4
.3
Th
e C
irc
ula
r F
low
Re
vis
ite
d
In F
igu
re 4
.6 w
e in
tegr
ate
gove
rnm
ent
into
th
e ci
rcu
lar
flo
w
mo
del
fi
rst
sho
wn
in
F
igu
re
2.2.
H
ere
flo
ws
(1)
thro
ugh
(4) a
re t
he
sam
e as
th
e co
rres
po
nd
ing
flo
ws
in t
hat
fi
gure
. F
low
s (1
) an
d (
2) s
ho
w b
usi
nes
s ex
pen
dit
ure
s fo
r th
e re
sou
rces
pro
vid
ed b
y h
ou
seh
old
s. T
hes
e ex
pen
dit
ure
sar
e co
sts
to b
usi
nes
ses
bu
t re
pre
sen
t w
age,
ren
t, i
nte
rest
,an
d p
rofi
t in
com
e to
ho
use
ho
lds.
Flo
ws
(3)
and
(4)
sh
ow
h
ou
seh
old
exp
end
itu
res
for
the
goo
ds
and
ser
vice
s p
ro-
du
ced
by
bu
sin
esse
s.N
ow
co
nsi
der
wh
at h
app
ens
wh
en w
e ad
d g
ove
rn-
men
t. F
low
s (5
) th
rou
gh (
8) i
llu
stra
te t
hat
go
vern
men
t m
akes
pu
rch
ases
in
bo
th p
rod
uct
an
d r
eso
urc
e m
arke
ts.
Flo
ws
(5)
and
(6)
rep
rese
nt
gove
rnm
ent
pu
rch
ases
of
such
p
rod
uct
s as
pap
er, c
om
pu
ters
, an
d m
ilit
ary
har
dw
are
fro
mp
riva
te b
usi
nes
ses.
Flo
ws
(7)
and
(8)
rep
rese
nt
gove
rnm
ent
pu
rch
ases
of
reso
urc
es.
Th
e F
eder
al g
ove
rnm
ent
emp
loys
and
pay
s sa
lari
es t
o m
emb
ers
of
Co
ngr
ess,
th
e ar
med
fo
rces
, Ju
stic
e D
epar
tmen
t la
wye
rs,
mea
t in
spec
tors
, an
dso
on
. S
tate
an
d l
oca
l go
vern
men
ts h
ire
and
pay
tea
cher
s,b
us
dri
vers
, p
oli
ce,
and
fir
efig
hte
rs.
Th
e F
eder
al g
ove
rn-
men
t m
igh
t al
so l
ease
or
pu
rch
ase
lan
d t
o e
xpan
d a
mil
i-ta
ry b
ase
and
a c
ity
mig
ht
bu
y la
nd
on
wh
ich
to
bu
ild
a n
ew
elem
enta
ry s
cho
ol.
Go
vern
men
t th
en p
rovi
des
pu
bli
c go
od
s an
d s
ervi
ces
to b
oth
ho
use
ho
lds
and
bu
sin
esse
s, a
s sh
ow
n b
y fl
ow
s
CH
APT
ER
4
The U.S. Eco
nomy: Private a
nd Public Sectors
83
(9)
and
(10
). T
o f
inan
ce t
ho
se p
ub
lic
goo
ds
and
ser
vice
s,
bu
sin
esse
s an
d h
ou
seh
old
s ar
e re
qu
ired
to
pay
tax
es,
ass h
ow
n b
y fl
ow
s (1
1) a
nd
(12
). T
hes
e fl
ow
s ar
e la
bel
ed a
s n
et
taxe
s to
in
dic
ate
that
th
ey
also
in
clu
de
“tax
es
in
tre
vers
e” i
n t
he
form
of
tran
sfer
pay
men
ts t
o h
ou
seh
old
s an
d s
ub
sid
ies
to b
usi
nes
ses.
Th
us,
flo
w (
11)
enta
ils
vari
-o
us
sub
sid
ies
to f
arm
ers,
sh
i pb
uil
der
s, a
nd
air
lin
es a
s w
ell
as i
nco
me,
sal
es,
and
exc
ise
taxe
s p
aid
by
bu
sin
esse
s to
go
vern
men
t. M
ost
su
bsi
die
s to
bu
sin
ess
are
“co
nce
aled
”in
th
e fo
rm o
f lo
w-i
nte
rest
lo
ans,
lo
an g
uar
ante
es,
tax
con
cess
ion
s, o
r p
ub
lic
faci
liti
es p
rovi
ded
at
pri
ces
bel
ow
th
eir
cost
. S
imil
arly
, fl
ow
(12
) in
clu
des
bo
th t
axes
(p
er-
son
al i
nco
me
taxe
s, p
ayro
ll t
axes
) co
llec
ted
by
gove
rn-
men
t d
irec
tly
fro
m
ho
use
ho
lds
and
tr
ansf
er
pay
men
ts
suc h
as
wel
fare
pay
men
ts a
nd
So
cial
Sec
uri
ty b
enef
its
pai
d
by
gove
rnm
ent.
Go
ve
rnm
en
t F
ina
nc
e
Ho
w l
arge
is
the
U.S
. p
ub
lic
sect
or?
Wh
at a
re t
he
mai
nex
pen
dit
ure
cat
ego
ries
of
Fed
eral
, sta
te, a
nd
lo
cal
gove
rn-
men
ts?
Ho
w a
re t
hes
e ex
pen
dit
ure
s fi
nan
ced
?
Go
ve
rnm
en
t P
urc
ha
ses
an
d T
ran
sfe
rs
We
can
get
an
id
ea o
f th
e si
ze o
f go
vern
men
t’s e
con
om
icro
le b
y ex
amin
ing
gove
rnm
ent
pu
rch
ases
of
goo
ds
and
serv
ices
an
d g
ove
rnm
ent
tran
sfer
pay
men
ts. T
her
e is
a s
ig-
nif
ican
t d
iffe
ren
ce b
etw
een
th
ese
two
kin
ds
of
ou
tlay
s:
•G
ove
rnm
en
t p
urc
has
es
are
exha
ust
ive;
the
pro
du
cts
pu
rch
ased
dir
ectl
y ab
sorb
(re
qu
ire
the
use
o
f) r
eso
urc
es a
nd
are
par
t o
f th
e d
om
esti
c o
utp
ut.
F
or
exam
ple
, th
e p
urc
has
e o
f a
mis
sile
ab
sorb
s th
e la
bo
r o
f p
hys
icis
ts a
nd
en
gin
eers
alo
ng
wit
h s
teel
, ex
plo
sive
s, a
nd
a h
ost
of
oth
er i
np
uts
. •
Tra
nsf
er p
aym
ents
are
non
exha
ust
ive;
they
do
no
t d
irec
tly
abso
rb r
eso
urc
es o
r cr
eate
ou
tpu
t. S
oci
al
Sec
uri
ty b
enef
its,
wel
fare
pay
men
ts, v
eter
ans’
ben
efit
s,
and
un
emp
loym
ent
com
pen
sati
on
are
exa
mp
les
of
tran
sfer
pay
men
ts. T
hei
r ke
y ch
arac
teri
stic
is t
hat
re
cip
ien
ts m
ake
no
cu
rren
t co
ntr
ibu
tio
n t
o d
om
esti
c o
utp
ut
in r
etu
rn f
or
them
.F
eder
al,
stat
e, a
nd
lo
cal
go
vern
men
ts s
pen
t $
44
13
bil
lio
n i
n 2
00
7.
Of
that
to
tal,
go
vern
men
t p
urc
has
es
FIGURE 4.6
Th
e c
irc
ula
r fl
ow
an
d t
he
pu
bli
c s
ec
tor.
fl
Go
ve
rnm
en
t b
uy
s p
rod
ucts
fro
m t
he
pro
du
ct
ma
rke
t a
nd
em
plo
ys
reso
urc
es
fro
m t
he
re
sou
rce
ma
rke
t to
pro
vid
e p
ub
lic g
oo
ds
an
d s
erv
ice
s to
ho
use
ho
lds
an
d b
usi
ne
sse
s. G
ov
ern
me
nt
fin
an
ce
s it
sfi
ex
pe
nd
itu
res
thro
ug
h t
he
ne
t ta
xe
s (t
ax
es
min
us
tra
nsf
er
pay
me
nts
) it
re
ce
ive
s fr
om
ho
use
ho
lds
an
d b
usi
ne
sse
s.
BUSINESSES
RESOURCE
MARKET
HOUSEHOLDS
PRODUCT
MARKET
GOVERNMENT
(10)
Goods
and s
erv
ices(7)
Expenditure
s
(8)
Reso
urc
es
(9)
Goods
and s
erv
ices
Net
taxes
(11)
Net
taxes
(12)
(5)
Expenditure
s
(6)
Goods
and
serv
ices
(2)
Lan
d,l
abor,
capital
,
(1)
Cost
s
(2)
Reso
urc
es
Goo
ds
and
serv
ices
(4)
(3)
Rev
enue
(4)
Go
ods
and
serv
ices
(3)
Co
nsu
mption
ex
penditure
s
(1)
Mo
ney
inco
me
(rents
,wag
es, i
nter
est,
profits
)
entr
epre
neuri
al a
bili
ty
PA
RT
ON
E
Intr
oduct
ion t
o E
conom
ics
and t
he E
conom
y84
Fe
de
ral
Fin
an
ce
N
ow
let
’s lo
ok
sep
arat
ely
at e
ach
of
the
Fed
eral
, sta
te, a
nd
lo
cal
un
its
of
gove
rnm
ent
in t
he
Un
ited
Sta
tes
and
co
m-
par
e th
eir
exp
end
itu
res
and
tax
es. F
igu
re 4
.8 t
ells
th
e st
ory
fo
r th
e F
eder
al g
ove
rnm
ent.
Fe
de
ral
Ex
pe
nd
itu
res
Fo
ur
area
s o
f F
eder
al s
pen
din
g s
tan
d o
ut:
(1
) p
ensi
on
s an
d i
nco
me
secu
rity
, (2
) n
atio
nal
def
ense
, (3
) h
ealt
h,
and
(4
) in
tere
st o
n t
he
pu
bli
c d
ebt.
Th
e pe
nsi
ons
and
inco
me
secu
rity
ca
teg
ory
in
clu
des
th
e m
any
inco
me-
mai
nte
nan
ce
pro
gra
ms
for
the
aged
, p
erso
ns
wit
hd
isab
ilit
ies
or
han
dic
aps,
th
e u
nem
plo
yed
, th
e re
tire
d,
and
fa
mil
ies
wit
h
no
b
read
win
ner
. T
his
ca
teg
ory
—d
om
inat
ed b
y th
e $
46
1 b
illi
on
pen
sio
n p
ort
ion
of
the
So
cial
Sec
uri
ty p
rog
ram
—ac
cou
nts
fo
r 3
4 p
erce
nt
of
tota
l F
eder
al e
xpen
dit
ure
s. (
Th
is c
hap
ter’
s L
ast
Wo
rdex
amin
es t
he
imp
act
of
the
agin
g U
.S. p
op
ula
tio
n o
n t
he
futu
re
fin
anci
ng
o
f th
is
area
o
f F
eder
al
spen
din
g.)
N
atio
nal
def
ense
acc
ou
nts
fo
r ab
ou
t 2
1 p
erce
nt
of
the
Fed
eral
bu
dg
et,
un
der
sco
rin
g t
he
hig
h c
ost
of
mil
itar
y p
rep
ared
nes
s. H
ealt
h
refl
ects
th
e co
st o
f g
ove
rnm
ent
hea
lth
pro
gra
ms
for
the
reti
red
(M
edic
are)
an
d p
oo
r(M
edic
aid
).
Inte
rest
on
th
e pu
blic
de
bt
is
a
sub
stan
tial
t
amo
un
t b
ecau
se t
he
pu
bli
c d
ebt
itse
lf i
s la
rge.
FIGURE 4.7
Go
ve
rnm
en
t p
urc
ha
ses,
tra
nsf
ers
, a
nd
tota
l sp
en
din
g a
s p
erc
en
tag
es
of
U.S
. o
utp
ut,
19
60
an
d2
00
7.
Go
ve
rnm
en
t p
urc
ha
ses
hav
e d
eclin
ed
as
a p
erc
en
tag
e o
f U
.S.
ou
tpu
t si
nce
19
60
. T
ran
sfe
r p
aym
en
ts,
ho
we
ve
r, h
ave
incre
ase
d b
y m
ore
tha
n t
his
dro
p, r
ais
ing
to
tal g
ov
ern
me
nt
spe
nd
ing
(p
urc
ha
ses
plu
s tr
an
sfe
rs)
fro
m 2
7 p
erc
en
t o
f U
.S.
GD
P in
19
60
to
ab
ou
t 3
2 p
erc
en
t to
day
.
Percentage of U.S. output
Year
15
10 5 0
20
25
30
35
2007
1960
Government
purchases
Gove
ornment
transfe
srpayments
Source:
Com
pile
d fro
mB
ure
au o
fEco
fnom
ic A
nal
ysis
dat
a, www.bea.gov.
wer
e $
26
71
bil
lio
n
and
g
ove
rnm
ent
tran
sfer
s w
ere
$1
74
2 b
illi
on
. F
igu
re 4
.7 s
ho
ws
thes
e am
ou
nts
as
per
-ce
nta
ges
of
U.S
. d
om
esti
c o
utp
ut
for
20
07
an
d c
om
par
es
them
to
per
cen
tag
es f
or
19
60
. G
ove
rnm
ent
pu
rch
ases
hav
e d
ecli
ned
fro
m a
bo
ut
22
to
19
per
cen
t o
f o
utp
ut
sin
ce
19
60
. Bu
t tr
ansf
er p
aym
ents
hav
e m
ore
th
an d
ou
ble
d a
s a
per
cen
tag
e o
f o
utp
ut—
fro
m 5
per
cen
t in
19
60
to
ab
ou
t 1
3 p
erce
nt
in 2
00
7. R
elat
ive
to U
.S. o
utp
ut,
to
tal g
ove
rn-
men
t sp
end
ing
is
thu
s h
igh
er t
od
ay t
han
it
was
47
yea
rsag
o. T
his
mea
ns
that
th
e ta
x re
ven
ues
req
uir
ed t
o f
inan
ce
go
vern
men
t ex
pen
dit
ure
s ar
e al
so h
igh
er. T
od
ay, g
ove
rn-
men
t sp
end
ing
an
d t
he
tax
reve
nu
es n
eed
ed t
o f
inan
ce i
t ar
e ab
ou
t 3
2 p
erce
nt
of
U.S
. o
utp
ut.
In
20
07
th
e so
-cal
led
Tax
Fre
edo
m D
ay in
th
e U
nit
ed
Sta
tes
was
Ap
ril
30
. O
n t
hat
day
th
e av
erag
e w
ork
er h
ad
earn
ed e
no
ug
h (
fro
m t
he
star
t o
f th
e ye
ar)
to p
ay h
is o
r h
er s
har
e o
f th
e ta
xes
req
uir
ed t
o f
inan
ce g
ove
rnm
ent
spen
din
g f
or
the
year
. T
ax F
reed
om
Day
arr
ives
eve
nla
ter
in s
ever
al o
ther
co
un
trie
s, a
s im
pli
ed i
n G
lob
al
Per
spec
tive
4.2
.
GLOBAL PERSPECTIVE 4.2
Total Tax Revenue as a Percentage of Total
Out put, Selected Nations*
A n
atio
n’s “
tax b
urd
en”
is i
ts t
ax r
eve
nue
fro
mal
l le
vels
of
go
vern
ment
as a
perc
enta
ge o
fit
s to
tal o
utp
ut
(GD
P).
Af
mo
ng
the w
orl
d’s indust
rial
ized n
atio
ns, S
outh
Ko
rea,
Jap
an, U
nit
ed
Stat
es
hav
e t
he lo
west
tax
burd
ens.
*Incl
udes
gove
rnm
ent
nonta
x re
venue
from
fees, ch
arff
gres, fi nes
and sa
les
of
gove
rnm
ent
pro
pert
y.
Source:O
r:
gran
izat
ion
for
Eco
ffnom
ic C
oope
ration
and D
evel
opm
ent. www.oecd.org.
Total Tax Revenue as
Percentage of GDP, 2007
10
30
40
50
60
20
Sw
eden
Denm
ark
Fra
nce
Fin
land
Ital
y
United K
ingd
om
Can
ada
Germ
any
Aust
ralia
Unit
ed S
tate
s
So
uth
Ko
rea
Japan
CH
APT
ER
4
The U
.S. E
conom
y: P
riva
te a
nd P
ublic
Sect
ors
85
Fe
de
ral T
ax
Re
ve
nu
es
Th
e re
ven
ue
sid
e o
f F
igu
re 4
.8 s
ho
ws
that
th
e p
erso
nal
inco
me
tax,
pay
roll
tax
es, a
nd
th
e co
rpo
rate
inco
me
tax
are
the
bas
ic r
even
ue
sou
rces
, ac
cou
nti
ng
resp
ecti
vely
fo
r 45
, 34
, an
d 1
4 ce
nts
of
each
do
llar
co
llec
ted
.
Pe
rso
na
l In
co
me
Ta
xT
he
personal income tax
is t
he
kin
gpin
of
the
Fed
eral
tax
sys
tem
an
d m
erit
s sp
ecia
lco
mm
ent.
Th
is t
ax i
s le
vied
on
tax
able
in
com
e, t
hat
is,
on
the
inco
mes
of
ho
use
ho
lds
and
un
inco
rpo
rate
d b
usi
nes
ses
afte
r ce
rtai
n e
xem
pti
on
s ($
3500
fo
r ea
ch h
ou
seh
old
mem
-b
er)
and
ded
uct
ion
s (b
usi
nes
s ex
pen
ses,
ch
arit
able
co
ntr
i-b
uti
on
s, h
om
e m
ort
gage
in
tere
st p
aym
ents
, ce
rtai
n s
tate
an
d l
oca
l ta
xes)
are
tak
en i
nto
acc
ou
nt.
Th
e F
eder
al p
erso
nal
in
com
e ta
x is
a p
rogr
essi
ve t
ax,
m
ean
ing
that
peo
ple
wit
h h
igh
er in
com
es p
ay a
larg
er p
er-
cen
tage
of t
hei
r in
com
es a
s ta
xes
than
do
peo
ple
wit
h lo
wer
inco
mes
. Th
e p
rogr
essi
vity
is
ach
ieve
d b
y ap
ply
ing
hig
her
ta
x ra
tes
to s
ucc
essi
ve l
ayer
s o
r b
rack
ets
of
inco
me.
C
olu
mn
s 1
an
d 2
in
Tab
le 4
.1
sh
ow
th
e m
ech
anic
s
of
the
inco
me
tax
for
a m
arri
ed c
ou
ple
fil
ing
a j
oin
t re
turn
in
20
08
. N
ote
th
at a
10
per
cen
t ta
x ra
te a
pp
lies
to
all
tax
able
in
com
e u
p t
o $
16
,05
0 a
nd
a 1
5 p
erce
nt
rate
ap
pli
es t
o a
dd
itio
nal
in
com
e u
p t
o $
65
,10
0.
Th
e ra
tes
on
ad
dit
ion
al l
ayer
s o
f in
com
e th
en g
o u
p t
o 2
5,
28
, 3
3,
and
35
per
cen
t.
Th
e ta
x ra
tes
sho
wn
in
co
lum
n 2
in
Tab
le 4
.1
ar
em
arg
inal
tax
rat
es.
A m
arginal tax rate
is
the
rate
at
wh
ich
th
e ta
x is
pai
d o
n e
ach
add
itio
nal
un
it o
f ta
xab
le
lin
com
e. T
hu
s, i
f a
cou
ple
’s t
axab
le i
nco
me
is $
80
,00
0,
they
wil
l pay
th
e m
arg
inal
rat
e o
f 1
0 p
erce
nt
on
eac
h d
ol-
lar
fro
m $
1 t
o $
16
,05
0,
15
per
cen
t o
n e
ach
do
llar
fro
m
$1
6,5
01
to
$6
5,1
00
, an
d 2
5 p
erce
nt
on
eac
h d
oll
ar f
rom
$6
5,1
01
to
$8
0,0
00
. Y
ou
sh
ou
ld c
on
firm
th
at t
hei
r to
tal
inco
me
tax
is $
12
,68
8.
Th
e m
argi
nal
tax
rat
es i
n c
olu
mn
2 o
vers
tate
th
e p
er-
son
al i
nco
me
tax
bit
e b
ecau
se t
he
risi
ng
rate
s in
th
at c
ol-
um
n a
pp
ly o
nly
to
th
e in
com
e w
ith
in e
ach
su
cces
sive
tax
b
rack
et.
To
get
a b
ette
rid
ea
of
the
tax
bu
rden
, w
e m
ust
co
nsi
der
av
er-
age
tax
rate
s. T
heaver-
age tax rate
is t
he
tota
lta
x p
aid
div
ided
by
tota
l tax
able
inco
me.
Th
e co
up
le in
ou
rp
revi
ou
s ex
amp
le i
s in
th
e 25
per
cen
t ta
x b
rack
et b
ecau
se
they
pay
a t
op
mar
gin
al t
ax r
ate
of
25 p
erce
nt
on
th
e h
igh
-es
t d
oll
ar o
f th
eir
inco
me.
Bu
t th
eir
aver
age
tax
rate
is
16
per
cen
t (5
$12,
688y
$80,
000)
.
TA
BLE
4.1
F
ed
era
l P
ers
on
al
Inc
om
e T
ax
Ra
tes,
20
08
*
(4)
Av
era
ge
(3
)
Ta
x R
ate
(1
)
(2)
T
ota
l T
ax
on
Hig
he
st
To
tal
Ma
rgin
al
on
Hig
he
stIn
co
me
in
Ta
xa
ble
Ta
xIn
co
me
In
Bra
ck
et,
%
Inc
om
eR
ate
,%B
rac
ke
t(3
)4
(1)
$1–$16,0
50
10.0
$ 1
605
10
$16,0
51–$65,1
00
15.0
8963
14
$65,1
01–$131,4
50
25.0
25,5
50
19
$131,4
51–$200,3
00
28.0
44,8
28
22
$200,3
01–$357,7
00
33.0
96,7
70
27
Ove
r $357,7
00
35.0
*For
am
arri
ed c
ouple
fi li
ng
a jo
int
retu
rn.
Nat
ional
defe
nse
21%
Heal
th
24%
Pensi
ons
&
inco
me s
ecuri
ty
34%
To
tal
ex
pe
nd
itu
re
s:
$2
73
1 b
illi
on
All o
ther
12%
Inte
rest
on
public d
ebt
9%
FIG
UR
E 4
.8F
ed
era
l e
xp
en
dit
ure
sa
nd
ta
x r
ev
en
ue
s, 2
00
7.
Fe
de
ral
ex
pe
nd
itu
res
are
do
min
ate
d b
y s
pe
nd
ing
fo
r
pe
nsi
on
s a
nd
inco
me
se
cu
rity
, h
ea
lth
, a
nd
nat
ion
al d
efe
nse
. A
fu
ll 7
9 p
erc
en
t o
f fe
de
ral t
ax
rev
en
ue
is d
eri
ve
d f
rom
just
tw
o s
ou
rce
s: t
he
pe
rso
na
l in
co
me
ta
x a
nd
pay
roll
tax
es.
Th
e $
163
bill
ion
dif
fere
nce
be
twe
en
ex
pe
nd
itu
res
an
d
rev
en
ue
s re
fle
cts
a b
ud
ge
t d
efi
cit
.
Pers
onal
inco
me t
ax
45%
Pay
roll
taxes
34%
Co
rpo
rate
inco
me t
ax
14%
Excis
e
taxes
3%
All o
ther
4%
To
tal
tax
re
ve
nu
es:
$2
56
8 b
illi
on
Source:
U.S
. Tre
asury
, Com
bined Statement of Receipts, O
utlays, and Balances, 2007, f
ms.
treas.
gov.
W 4
.1
Tax
es
and P
rogre
ssiv
ity
WO
RK
ED
PR
OB
LE
MS
