Economic Challenges Facing Contemporary Business

Microeconomics: The Forces of Demand and Supply

At the heart of every business transaction is an exchange between a buyer and a seller. The buyer recognizes that he or she needs or wants a particular good or service—whether it's a hamburger or a haircut—and is willing to pay a seller for it. The seller enters into the exchange to generate revenue and earn a profit. So, the exchange process involves both demand from consumers and supply from producers. Specifically, demand refers to the willingness and ability of buyers to purchase goods and services at different prices. The other side of the process is supply, the amount of goods and services for sale at different prices. Understanding the factors that determine demand and supply, as well as how the two interact, can help you understand many actions and decisions of individuals, businesses, and government. This section takes a closer look at these concepts.

FACTORS DRIVING DEMAND

For most of us, economics amounts to choices we make with our scarce resources, principally money and time. Each person must therefore choose how much money to save (for future consumption) and how much to spend (present consumption). If we use our money for present consumption, we must decide among all the goods and services competing for our attention. Suppose you wanted to purchase a smart phone. You'd have to choose from a variety of brands and models. You'd also have to decide where you wanted to buy one. After shopping around, you might decide you didn't want a smart phone at all. Instead, you might purchase something else or save your money. All of these choices are part of the landscape that is microeconomics.

Demand for any good or service is driven by a number of factors that influence how people decide to spend their money, by outside circumstances, or larger economic events such as the recent recession. Typically, consumers will tend to purchase more of a good if the price is lower and less of a good if the price is higher (think about items on sale, where lower prices often attracts more buyers). A demand curve is a graph of the amount of a product that buyers will purchase at different prices. Demand curves typically slope downward, meaning that lower and lower prices attract larger and larger purchases.

Gasoline provides a classic example of how demand curves work. The left side of FIGURE 3.1 shows a possible demand curve for the total amount of gasoline that people will purchase at different prices. The prices shown may not reflect the actual price in your location at this particular time, but they still demonstrate the concept. When gasoline is priced at $3.76 a gallon, drivers may fill up their tanks once or twice a week. However, when the price of gasoline goes up—say, to $4.06 a gallon—many consumers start economizing. They may combine errands or carpool to work. So, the quantity of gasoline demanded at $4.06 a gallon is lower than the amount demanded at $3.76 a gallon. The opposite happens at $3.36 a gallon. More gasoline is sold at $3.36 a gallon than at $3.76 a gallon, as people opt to take a weekend trip.

Movement along a demand curve is caused by changes in the price of the good. However, the overall demand for a product at any price can change as well, increasing or decreasing demand at all prices. Many factors can combine to determine the overall demand for a product—that is the shape and position of the demand curve. These influences include customer preferences and income, the prices of substitute and complementary items, whether the good is a necessity or a luxury, the number of buyers in a market, and the strength of their optimism regarding the future. Changes in any of these factors produce a new demand curve. Changes in household income also change demand. As consumers have more money to spend, firms can sell more services and merchandise at every price. This means the demand curve has shifted to the right. When income shrinks, nearly everyone suffers, and the demand curve shifts to the left. TABLE 3.1 describes how a demand curve is likely to respond to each of these changes.

FACTORS DRIVING SUPPLY

As consumers are willing to buy more goods at lower prices, sellers are willing to produce more products if they can sell them at higher prices. A supply curve shows the relationship between different prices and the quantities that sellers will offer for sale, regardless of demand. Movement along the supply curve is the opposite of movement along the demand curve. As prices rise, the quantity that sellers are willing to supply also rises. At progressively lower prices, the quantity supplied decreases. In FIGURE 3.2, a possible supply curve for gasoline shows that increasing prices for gasoline should bring increasing supplies to market.

TABLE 3.2 summarizes how changes in various factors can affect the supply curve. Sometimes forces of nature can affect the supply curve.

HOW DEMAND AND SUPPLY INTERACT

Separate shifts in demand and supply have obvious effects on prices and the availability of products. In the real world, factors affecting the supply and demand often change at the same time—and they keep changing. Sometimes such changes cause contradictory pressures on prices and quantities. In other cases, the final direction of prices and quantities reflects the factor that has changed the most.

FIGURE 3.3 shows the interaction of both supply and demand curves for gasoline on a single graph. Notice that the two curves intersect at P. The law of supply and demand states that prices (P) are set by the intersection of the supply and demand curves. The point where the two curves meet identifies the equilibrium price, the prevailing market price at which you can buy an item. It is important to note that the equilibrium price is an imaginary point, as prices and quantities are constantly changing. Every purchase moves the point slightly and causes a ripple effect as both consumers and producers react to the new market prices.

As pointed out earlier, the forces of demand and supply can be affected by a variety of factors. One important variable is the larger economic environment. The next section explains how macroeconomics and economic systems influence market forces and, ultimately, demand, supply, and prices.

Macroeconomics: Issues for the Entire Economy

Each nation's policies and the choices their citizens make help determine its economic system, and although some are similar, no two countries have exactly the same economic system. In general, however, these systems can be classified into three categories: private enterprise systems; planned economies; or combinations of the two, referred to as mixed economies. As business becomes an increasingly global undertaking, it is important to understand the primary features of the various economic systems operating around the world.

CAPITALISM: THE PRIVATE ENTERPRISE SYSTEM AND COMPETITION

Most industrialized nations operate economies based on the private enterprise system, also known as capitalism or a market economy. A private enterprise system rewards businesses for meeting the needs and demands of consumers. Government tends to favor a hands-off attitude toward controlling business ownership, profits, and resource allocations. Instead, competition regulates economic life, creating opportunities and challenges that businesspeople must handle to succeed.

The relative competitiveness of a particular industry is an important consideration for every firm because it determines the ease and cost of doing business within that industry. Four basic types of competition take shape in a private enterprise system: pure competition, monopolistic competition, oligopoly, and monopoly. TABLE 3.3 highlights the main differences among these types of competition.

Pure competition is a market structure, like that of small-scale agriculture or fishing, in which large numbers of buyers and sellers exchange homogeneous products and no single participant can significantly influence price. Instead, prices are set by the market as the forces of supply and demand interact. Firms can easily enter or leave a purely competitive market because no single company dominates. Also, in pure competition, buyers see little difference between the goods and services offered by competitors.

The fishing industry is a good example of pure competition. The oysters, clams, and mussels that one fishing boat gathers are virtually identical to those gathered by others. In this type of market, suppliers become what is known as “price takers.” The market price is set through intermediaries (for example, canneries and wholesalers), and the fishermen have to take the market price for their catch. Because they are selling nearly identical goods, they have little or no ability to influence the price of the goods. For fishermen, becoming a price taker all changes when poisonous “red tides” of algae contaminate the season's supply of shellfish. When this happens, fishermen with uncontaminated shellfish can get much higher prices for their product.

Monopolistic competition is a market structure, like that of retailing, in which large numbers of buyers and sellers exchange differentiated (heterogeneous) products, so each participant has some control over price. Sellers can differentiate their products from competing offerings on the basis of price, quality, or other features. In an industry that features monopolistic competition, it is relatively easy for a firm to begin or stop selling a good or service. The success of one seller often attracts new competitors to such a market. Individual firms also have some control over how their goods and services are priced.

One example of monopolistic competition is the market for pet food. Consumers can choose from private-label products (store brands such as Walmart's Ol'Roy) and brand-name products like Purina. Producers of pet food and the stores that sell it have wide latitude in setting prices. Consumers can choose the store or brand with the lowest prices, or sellers can convince them that a more expensive offering—for example, the Fromm brand—is worth more because it offers better nutrition or other benefits.

An oligopoly is a market situation in which relatively few sellers compete and high start-up costs serve as barriers to new competitors. In some oligopolistic industries, such as paper and steel, competitors offer similar products. In others, such as aircraft and automobiles, they sell different models and features. The huge investment required to enter an oligopoly market tends to discourage new competitors. The limited number of sellers also enhances the control these firms exercise over price. Competing products in an oligopoly usually sell for very similar prices because substantial price competition would reduce profits for all firms in the industry. So a price cut by one firm in an oligopoly will typically be met by its competitors. However, prices can vary from one market to another, as from one country to another.

The final type of market structure is a monopoly, in which a single seller dominates the trade of a good or service for which buyers can find no close substitutes. A pure monopoly occurs when a firm possesses characteristics so important to competition in its industry that they form barriers to prevent entry by would-be competitors. In contrast to markets that are purely competitive, firms with monopoly power almost always become “price setters” as they control the supply and hence the price of products in the market. The cartel of the Organization of the Petroleum Exporting Countries (OPEC) operates in such a way, attempting to set prices for crude oil on the world market.

Because a monopoly market lacks the benefits of competition, many governments regulate monopolies. For example, the U.S. government prohibits most pure monopolies through antitrust legislation such as the Sherman Act and the Clayton Act. The government has applied these laws against monopoly behavior by Microsoft and by disallowing proposed mergers of large companies in some industries. In other cases, the government permits certain monopolies in exchange for regulating their activities.

Many firms create short-term monopolies when research breakthroughs permit them to receive exclusive patents on new products. In the pharmaceuticals industry, drug giants such as Merck and Pfizer invest billions in research and development programs. When the research leads to successful new drugs, the companies can enjoy the benefits of their patents: the ability to set prices without fear of competitors undercutting them. Once the patent expires, generic substitutes enter the market, driving down prices.

With regulated monopolies, a local, state, or federal government grants exclusive rights in a certain market to a single firm. Pricing decisions—particularly rate increase requests—are subject to control by regulatory authorities such as state public service commissions. An example is the delivery of first-class mail, a monopoly held by the U.S. Postal Service (USPS). The USPS is a self-supporting corporation wholly owned by the federal government. Its postal rates are set by a postal commission and approved by a board of governors.

During the 1980s and 1990s, the U.S. government trended away from regulated monopolies and toward deregulation. Regulated monopolies that have been deregulated include long-distance and local telephone service, cable television, cell phones, airlines, and electric utilities. The idea is to improve customer service and reduce prices for customers through increased competition. In contrast, the Federal Communication Commission's (FCC's) restrictions preventing a single company from owning TV stations, newspapers, and other media in the same market continue to be challenged. When newspapers are struggling to survive, companies are asking the FCC to change their rules or grant waivers so that TV stations and newspapers can share resources under one company.²

PLANNED ECONOMIES: SOCIALISM AND COMMUNISM

In a planned economy, government controls determine business ownership, profits, and resource allocation to accomplish government goals rather than those set by individual firms. Two forms of planned economies are communism and socialism.

Socialism is characterized by government ownership and operation of major industries such as communications. Socialists argue that major industries like medical care are too important to a society to be left in private hands, and that government-owned businesses can serve the public's interest better than private firms. However, socialism allows private ownership in industries considered less crucial to social welfare, such as retail shops, restaurants, and certain types of manufacturing facilities. Scandinavian countries such as Denmark, Sweden, and Finland have many socialist features in their societies, as do some African nations—such as Tanzania, Zambia, and Namibia—and India.

The writings of Karl Marx in the mid-1800s formed the basis of communist theory. Marx believed that private enterprise economies created unfair conditions and led to worker exploitation because business owners controlled most of society's resources and reaped most of the economy's rewards. Instead, he suggested an economic system called communism, in which all property would be shared equally by the people of a community under the direction of a strong central government. Marx believed that elimination of private ownership of property and businesses would ensure the emergence of a classless society that would benefit all. Each individual would contribute to the nation's overall economic success, and resources would be distributed according to each person's needs. Under communism, the central government owns the means of production, and the people work for state-owned enterprises. The government determines what people can buy because it dictates what is produced in the nation's factories and farms.

Several nations adopted communist-like economic systems during the early 20th century in an effort to correct what they saw as abuses in their existing systems. In practice, however, under these new governments individuals typically found less freedom of choice in regard to jobs and purchases. Consider the former Soviet Union, where large government bureaucracies controlled nearly every aspect of daily life. Shortages became chronic because producers had little or no incentive to satisfy customers. The quality of goods and services also suffered for the same reason. When Mikhail Gorbachev became the last president of the dying Soviet Union, he tried to improve the quality of Soviet-made products. Effectively shut out of trading in the global marketplace and caught up in a treasury-depleting arms race with the United States, the Soviet Union faced severe financial problems. Eventually, these events led to the collapse of Soviet communism and the breakup of the Soviet Union itself.

Today, communist-like systems exist in just a few countries, such as North Korea. By contrast, the People's Republic of China has shifted toward a more market-oriented economy. The national government has given local government and individual plant managers more say in business decisions and has permitted some private businesses. Households now have more control over agriculture, in contrast to the collectivized farms introduced during an earlier era. In addition, Western products such as McDonald's restaurants and Coca-Cola soft drinks are now part of Chinese consumers' lives, and Chinese workers manufacture products for export to other countries.

MIXED MARKET ECONOMIES

Private enterprise systems and planned economies adopt basically opposite approaches to operating their economies. In reality though, many countries operate mixed market economies, economic systems that mix both types of economies, to different degrees. In nations generally considered to have a private enterprise economy, government-owned firms frequently operate alongside private enterprises.

France has blended socialist and free enterprise policies for hundreds of years. The nation's energy production, public transportation, and defense industries are operated as nationalized industries, controlled by the government. Meanwhile, a market economy operates in other industries. Over the past two decades, the French government has loosened its reins on state-owned companies, inviting both competition and private investment into industries previously operated as government monopolies.

The proportions of private and public enterprise can vary widely in mixed economies, and the mix frequently changes. Dozens of countries have converted government-owned and -operated companies into privately held businesses in a trend known as privatization. Even the United States has seen proposals to privatize everything from the postal service to Social Security.

Governments may privatize state-owned enterprises in an effort to raise funds and improve their economy. The objective is to cut costs and run the operation more efficiently. For most of its existence, Air Canada was a state-owned airline. But in 1989 the airline became fully privatized, and in 2000 the firm acquired Canadian Airlines International, becoming the world's tenth-largest international air carrier. Air Canada now maintains an extensive global network, with destinations in the United States, Europe, the Middle East, Asia, Australia, the Caribbean, Mexico, and South America.³ TABLE 3.4 compares the alternative economic systems on the basis of ownership and management of enterprises, rights to profits, employee rights, and worker incentives.

Evaluating Economic Performance

Ideally, an economic system should provide two important benefits for its citizens: a stable business environment and sustained growth. In a stable business environment, the overall supply of needed goods and services is aligned with the overall demand for these items. No wild fluctuations in price or availability make economic decisions complicated. Consumers and businesses not only have access to ample supplies of desired products at affordable prices but also have money to buy the items they demand.

Growth is another important economic goal. An ideal economy incorporates steady change directed toward continually expanding the amount of goods and services produced from the nation's resources. Growth leads to expanded job opportunities, improved wages, and a rising standard of living.

FLATTENING THE BUSINESS CYCLE

A nation's economy tends to flow through various stages of a business cycle: prosperity, recession, depression, and recovery. Decisions made by businesses and consumers differ at each stage of the business cycle. In periods of economic prosperity, unemployment is typically low, confidence about the future is high, and consumers make more purchases. In response to increased demand, businesses expand—by hiring more employees, investing in new technology, and making similar purchases—to take advantage of new opportunities.

While we all enjoy times of prosperity, there comes a point in the economic cycle when consumers begin to pull back on their purchases. Either they are concerned about their rising debt level or some economic event happens to shake their confidence. When this happens, consumers begin to postpone their major purchases and shift buying patterns toward basic, low-priced products. Businesses mirror these changes by slowing production, postponing expansion plans, reducing inventories, and often cutting the size of their workforce. As economic activity slows down, the rate of economic growth is reduced. If the economic contraction lasts for six months or longer, the country is said to be in recession. FIGURE 3.4 illustrates the various elements of the business cycle, showing economic recessions, expansions, recoveries, and booms.

During recessions, people facing layoffs and depletions of household savings become much more conservative in their spending, postponing luxury purchases and vacations. They often turn to lower-priced retailers like Dollar Tree and Dollar General for the goods they need. And they may have sold cars, jewelry, and stocks to make ends meet. They have also sold everything from old books to artwork to kitchenware on eBay.

A depression can occur if the economic slowdown continues for an extended period of time or is particularly severe (significant drop in gross domestic product [GDP]). Many Americans have grown up hearing stories about their great-grandparents who lived through the Great Depression of the 1930s, when food and other basic necessities were scarce and jobs were even scarcer.

In the recovery stage of the business cycle, the economy emerges from recession and consumer spending picks up. Even though businesses often continue to rely on part-time and other temporary workers during the early stages of recovery, unemployment begins to decline as business activity accelerates and firms seek additional workers to meet growing production demands. Gradually, the concerns of recession begin to disappear, and consumers start visiting Olive Garden restaurants, booking Florida vacations, and buying new Kias.

PRODUCTIVITY AND THE NATION'S GROSS DOMESTIC PRODUCT

An important concern for every economy is productivity, the relationship between the goods and services produced in a nation each year and the inputs needed to produce them. In general, as productivity rises, so does an economy's growth and the wealth of its citizens. In a recession, productivity stalls or even declines.

Productivity describes the relationship between the number of units produced and the number of human and other production inputs necessary to produce them. Productivity is a ratio of output to input. When a constant amount of inputs generates increased outputs, an increase in productivity occurs.

Total productivity considers all inputs necessary to produce a specific amount of outputs. Stated in equation form, it can be written as follows:

Many productivity ratios focus on only one of the inputs in the equation: labor productivity or output per labor-hour. An increase in labor productivity means that the same amount of work produces more goods and services than before. Many of the gains in U.S. productivity can be attributed to technology.

Productivity is a widely recognized measure of a company's efficiency. In turn, the total productivity of a nation's businesses has become a measure of its economic strength and standard of living. Economists refer to this measure as a country's gross domestic product (GDP)—the sum of all goods and services produced within its boundaries. The GDP is based on a country's per-capita output—in other words, total national output divided by the number of citizens. As FIGURE 3.5 shows, only the European Union—which includes 28 member nations and an estimated GDP of $15.48 trillion—has a GDP higher than that of the United States.⁴ In the United States, GDP is tracked by the Bureau of Economic Analysis (BEA), a division of the U.S. Department of Commerce. Current updates and historical data on the GDP are available at the BEA's Web site (http://www.bea.gov).

PRICE LEVEL CHANGES

An important indicator of an economy's stability is the general level of prices. For the last 100 years, economic decision makers concerned themselves with inflation, rising prices caused by a combination of excess consumer demand and increases in the costs of raw materials, component parts, human resources, and other factors of production. The core inflation rate is the inflation rate of an economy after energy and food prices are removed. This measure is often an accurate prediction of the inflation rate that consumers, businesses, and other organizations can expect to experience during the near future.

America's most severe inflationary period during the last half of the 20th century peaked in 1980, when general price levels jumped almost 14 percent in a single year. In extreme cases, an economy may experience hyperinflation—an economic situation characterized by soaring prices. This situation has occurred in Zimbabwe, Argentina, and countries that once formed the Soviet Union (for example, Belarus).

Inflation devalues money as persistent price increases reduce the amount of goods and services people can purchase with a given amount of money. This is bad news for people whose earnings do not keep up with inflation, who live on fixed incomes, or who have most of their wealth in investments paying a fixed rate of interest. Inflation can be good news for people whose income is rising or those with debts at a fixed rate of interest.

The opposite situation—deflation—occurs when prices continue to fall. In Japan, where deflation has been a reality for several years, shoppers pay less for a variety of products ranging from groceries to homes. While this situation may sound ideal to consumers, it can weaken the economy. For instance, if consumers believe that prices will be cheaper in the future. they are likely to postpone their purchases. When all consumers do this, it then becomes self-fulfilling as producers react to the lower demand by further reducing their prices. Seeing the reduced prices, consumers are willing to postpone their purchases once again. And so the cycle goes. Without predictable prices, industries such as housing and auto manufacturing cannot operate effectively, and weak demand in these sectors tends to depress the rest of the economy.

In the United States, the government tracks changes in price levels with the Consumer Price Index (CPI), which measures the monthly average change in prices of goods and services. The federal Bureau of Labor Statistics (BLS) calculates the CPI monthly based on prices of a “market basket,” a compilation of the goods and services most commonly purchased by urban consumers. FIGURE 3.6 shows the categories included in the CPI market basket. Each month, BLS representatives visit thousands of stores, service establishments, rental units, and doctors' offices across the United States to price the many items in the CPI market basket. From these data they create the CPI, providing a running measurement of changes in consumer prices.

EMPLOYMENT LEVELS

People need money to buy the goods and services produced in an economy. Because most consumers earn that money by working, the number of people in a nation who currently have jobs is an important indicator of how well the economy is doing. In general, employment has dropped during the recent U.S. recession, although it recently began to rebound. Areas that have seen gains include professional and technical services, as well as education, health care, and social assistance.⁵

Economists refer to a nation's unemployment rate as an indicator of its economic health. The unemployment rate is usually expressed as a percentage of the total workforce actively seeking work but who are currently unemployed. The total labor force includes all people who are willing and available to work at the going market wage, whether they currently have jobs or are seeking work. The U.S. Department of Labor, which tracks unemployment rates, also measures so-called discouraged workers and “underemployed” workers. Discouraged workers are individuals who want to work but have given up looking for jobs. Underemployed workers are individuals who have taken lower-paying positions than their qualifications would suggest. Unemployment can be grouped into the four categories: frictional, seasonal, cyclical, and structural.

Frictional unemployment is experienced by members of the workforce who are temporarily not working but are looking for jobs. This pool of potential workers includes new graduates, people who have left jobs for any reason and are looking for other employment, and former workers who have decided to return to the labor force. Service personnel who have recently left the armed forces fall into this category as well. However. for some of them, finding employment may have gotten a bit easier, as Walmart recently announced that they would hire 100,000 veterans.⁶

Cyclical unemployment includes people who are out of work because of a cyclical contraction in the economy. During periods of economic expansion, overall employment is likely to rise, but as growth slows and a recession begins, unemployment levels commonly rise. At such times, even workers with good job skills may face temporary unemployment.

Structural unemployment applies to people who remain unemployed for long periods of time, often with little hope of finding new jobs like their old ones. This situation may arise because these workers lack the necessary skills for available jobs or because the skills they have are no longer in demand, such as some types of factory workers.

Managing the Economy's Performance

Government can use both monetary policy and fiscal policy in its efforts to fight unemployment, increase business and consumer spending, and reduce the length and severity of economic recessions. For instance, the Federal Reserve System can increase or reduce interest rates, and the federal government can enact tax cuts and rebates or propose other reforms.

MONETARY POLICY

A common method of influencing economic activity is monetary policy, government actions to increase or decrease the money supply and change banking requirements and interest rates to influence spending by altering bankers' willingness to make loans. An expansionary monetary policy increases the money supply in an effort to cut the cost of borrowing, which encourages business decision makers to make new investments, in turn stimulating employment and economic growth. By contrast, a restrictive monetary policy reduces the money supply to curb rising prices, overexpansion, and concerns about overly rapid economic growth.

In the United States, the Federal Reserve System (“the Fed”) is responsible for formulating and implementing the nation's monetary policy. It is headed by a chairman and board of governors, all of whom are nominated by the president. The current chairman is Ben Bernanke, who also serves as chairman of the Federal Open Market Committee, the Fed's main agency for monetary policymaking. All national banks must be members of this system and keep some percentage of their checking and savings funds on deposit at the Fed.

The Fed's board of governors uses a number of tools to regulate the economy. By changing the required percentage of checking and savings accounts that banks must deposit with the Fed, the governors can expand or shrink funds available to lend. The Fed also lends money to member banks, which in turn make loans at higher interest rates to business and individual borrowers. By changing the interest rates charged to commercial banks, the Fed affects the interest rates charged to borrowers and, consequently, their willingness to borrow.

FISCAL POLICY

Governments also influence economic activities by making decisions about taxes and spending. Through revenues and expenses, the government implements fiscal policy, a set of decisions designed to control inflation, reduce unemployment, improve the general standard of living, and encourage economic growth.

THE FEDERAL BUDGET

Each year, the president proposes a budget for the federal government, a plan for how it will raise and spend money during the coming year, and presents it to Congress for approval. A typical federal budget proposal undergoes months of deliberation and many modifications before receiving approval. The federal budget includes a number of different spending categories, ranging from defense and Social Security to interest payments on the national debt (FIGURE 3.7). The decisions about what to include in the budget have a direct effect on various sectors of the economy. For example, during a recession, the federal government may approve increased spending on interstate highway repairs to improve transportation and increase employment in the construction industry. During prosperity, the government may allocate more money for scientific research.

The primary sources of government funds to cover the costs of the annual budget are taxes, fees, and borrowing. Both the overall amount of these funds and their specific combination have major effects on the economic well-being of the nation. One way governments raise money is to impose taxes on sales, income, and other sources. But increasing taxes leaves people and businesses with less money to spend. This might reduce inflation, but overly high taxes can also slow economic growth. Governments then try to balance taxes to give people necessary services without slowing economic growth.

Taxes don't always generate enough funds to cover every spending project the government hopes to undertake. When the government spends more than the amount of money it raises through taxes, it creates a budget deficit. To cover the deficit, the U.S. government borrows money by selling Treasury bills, Treasury notes, and Treasury bonds to investors. All of this borrowing makes up the national debt. If the government takes in more money than it spends, it is said to have a budget surplus. A balanced budget means total revenues raised by taxes equal the total proposed spending for the year.

Achieving a balanced budget—or even a budget surplus—does not erase the national debt. U.S. legislators continually debate how to use revenues to reduce its debt. Most families want to wipe out debt—from credit cards, automobile purchases, and college, to name a few sources. To put the national debt into personal perspective, with roughly 314 million U.S. citizens, each one owes about $53,300 as his or her share.⁷

But for the federal government, the decision is more complex. When the government raises money by selling Treasury bills, it makes safe investments available to investors worldwide. If foreign investors cannot buy Treasury notes, they might turn to other countries, reducing the amount of money flowing into the United States. U.S. government debt has also been used as a basis for pricing riskier investments. If the government issues less debt, the interest rates it commands are higher, raising the overall cost of debt to private borrowers. In addition, the government uses the funds from borrowing, at least in part, to pay for such public services as education and scientific research.

NOTES

1. Claudia Buck, “Lackluster Job Market Drives Thousands of Young Adults Back Home to Live with Parents,” The Sacramento Bee, April 4, 2013, www.sacbee.com; Rebecca Trounson, “Boomerang Babies Don't Mind Return,” Chicago Tribune, March 20, 2012.

2. Amy Chozick, “F.C.C Shift May Thwart a Murdoch Media Deal,” New York Times, March 24, 2013, http://www.nytimes.com.

3. Company Web site, http://www.aircanada.com, accessed April 9, 2013.

4. World Factbook, Central Intelligence Agency, http://www.cia.gov, accessed April 9, 2013.

5. Occupational Outlook Handbook 2012–2013 Edition, U.S. Bureau of Labor Statistics, http://www.bls.gov, accessed April 9, 2013.

6. Emily Jane Fox, “Wal-Mart to Hire 100,000 Veterans,” CNN Money, http://money.cnn.com, January 15, 2013.

7. U.S. National Debt Clock, http://www.brillig.com, accessed April 24, 2013.