Assignment for tomorrow

Improving Efficiency Write a 2-page paper describing how trade, comparative advantages, and specialization can aid in improving efficiency of individuals, firms, and/or countries.

Economics Introduction

Economics is a relatively new science, deriving its core focus on human behavior and the interaction of scarce resources in markets from the likes of Adam Smith, David Ricardo, John Baptiste Say, Frederick Hayek, and John Maynard Keynes.

Particularly at its core beginning and notions of free markets, scarcity, specialization, and free allocation of resources was Adam Smith’s book, An Inquiry into the Nature and Causes of the Wealth of Nations, which he published in 1776.

· When we study economics, we are inherently studying society’s problem of scarcity and the difficult decisions we make and must make in order to increase fairness, equity, and efficiency in our society.

· That is the economic problem. How do we satisfy human beings’ unlimited wants and their needs with finite resources? What do we produce? How do we produce it? For whom do we produce it? Those are the questions we must answer based upon our investigation into scarcity, choice, and resources.

What if we had everything we needed and wanted without ever coming up short? Would there be a word called scarcity? Not if we had everything satisfy all of society’s needs and wants. But we do.

One may think we have an infinite source of water, but we don’t. Despite seventy-five percent of the Earth covered in water, only about less than 5% of it is fresh water. Despite air being invisible and seemingly infinite, clean air is a luxury today. So, when we talk about resources being scarce and non-renewable, we must understand that we in society must make decisions based upon scarcity and determine what the optimal allocation of our resources is going to be to maximize our society’s wealth, happiness, efficiency, and equity.

Why do you suppose some countries, such as the United States, are relatively well off and its people have relatively ample and even abundant resources with which to live their lives, while other countries have relatively little?

· It comes down to the resources, which includes human, those of nature, and technology, which a country and its government possess and the allocation of those resources in its markets.

· Secondly, how much private property rights do the inhabitants possess according to the specific governmental structure within their country?

· More private property rights means more freedom to choose, retain resources, and seek a higher standard of living. Private property rights allows entrepreneurism to flourish by allowing the entrepreneur to invest his or her own personal resources and taking risks to make a venture successful.

How do we assess our views of scarcity? Do we simply project our desires or opinions about what is transpiring, or do we gather data and apply economic models and theory to understand the world around us?

That is the difference between normative economics and positive economics. Simply stating what something ought to be or what you want something to be is normative economics.

Applying data and economic models and theory to help us understand and predict economic behavior is positive economics; positive economics implies what it is, not what it ought to be.

· Normative economics can help us strive for an ultimate outcome if we can more efficiently and effectively allocate resources, but employing positive economics gives us the true situation at hand we face and what we need to do and what to expect if certain criteria are present and what choices we should and plan to make.

· Thus, when we look at scarcity, we have to take into consideration the limited resources we possess in relation to the unlimited wants and needs we in society have. Scarcity affects individuals, firms, and countries.

Individuals, firms, and countries each make choices about how to allocate resources. Trade is used to more efficiently utilize a country’s comparative advantages in producing products with the resources it possesses.

Countries where private property rights are highest tend to have more market-oriented economies in which maximizing resources and profitability are sought and individuals enjoy higher standards of living.

Simply stating opinion and how something should be without utilizing economic models, theories, and data doesn’t allow for effective problem solving. Positive economics is when we do apply models, theories, and data to assess and predict economic behavior and solutions.

Two Main Economic Systems

As we continue on the discussion about scarcity, it is very crucial to analyze the specific economic structures that are established in society, and how the governments of those economic structures allocate resources in relation to their inhabitants. Two main economic systems exist, based upon the amount of government ownership of resources and private property rights allowed to the inhabitants of the countries: Capitalism and Socialism.

Capitalism is the economic system in which private ownership of productive resources are allocated through markets and market prices. When individuals, also referred to as “households,” in an economic system provide their factors of production – land, labor, and capital – to firms, they are compensated by firms in the form of income, wages, rent, and interest.

· Firms use those factors of production to produce the goods and services individuals need and want out of firms.

· It is from the income, wages, rent, and interest that individuals, or households, purchase those goods and services. A capitalist system operates just like this in which individuals are rewarded for the use of their resources.

Within a capitalist system, the government plays an important role of overseeing and regulating markets to ensure they are competitive and free of collusion and corruption. The government’s role is less of an owner of assets and resources as much as it is to oversee markets to ensure marginal social benefits and marginal social costs are in equilibrium, leading to social equity and efficiency.

Socialism is the other main economic system in which there is much more involvement in the ownership of firms and resources, as well as manipulation of markets by government. Taxation tends to be higher in these kinds of economic and governmental systems.

· Referring back to the notion of individuals and households providing their factors of production to firms in exchange for income, wages, rent, and interest, when higher taxation is imposed, that is a leakage to that process of exchange; individuals and households are not getting paid fully for the use of their resources, in effect, and thus private property rights are less in these kinds of economic systems.

In summary, economies can be broken down into two main economic systems: Capitalism and Socialism. Capitalism entails less government involvement in market systems, and there is more freedom between the households and firms in the exchange process of the factors of production and the generation of goods and services.

Private property rights is higher in capitalism due to less government ownership and less taxation of individuals. Socialism, on the other hand, involves more government ownership of resources and firms, as well as higher taxation of individuals, thus reducing the private property rights of individuals.

The Economic Approach

GWARTNEY – STROUP – SOBEL – MACPHERSON

To Accompany: “Economics: Private and Public Choice, 15th ed.”
James Gwartney, Richard Stroup, Russell Sobel, & David Macpherson
Slides authored and animated by: James Gwartney & Charles Skipton
Full Length Text —
Micro Only Text —
Part: 1
Part: 1
Chapter: 1
Chapter: 1
Macro Only Text —
Part: 1
Chapter: 1

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What is Economics About?

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Scarcity and Choice
Scarcity and choice are the two essential ingredients
of an economic topic.
Goods are scarce because desire for them far outstrips their availability from nature.
Scarcity forces us to choose among available alternatives.

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History is a record of our struggle to transform available, but limited, resources …
Scarce Goods
Food (bread, milk, meat, eggs,
vegetables, coffee, etc.)
Clothing (shirts, pants, blouses, shoes,
socks, coats, sweaters, etc.)
Household (tables, chairs, rugs, beds,
goods dressers, television sets, etc.)
Education
National defense
Leisure time
Entertainment
Clean air
Pleasant (trees, lakes, rivers,
environment open spaces, etc.)
Pleasant working conditions
Limited Resources
Land (various degrees of fertility)
Natural (rivers, trees, minerals,
Resources oceans, etc.)
Machines and other
human-made physical resources
Non-human animal resources
Technology (physical and scientific
“recipes” of history)
Human (the knowledge, skill,
resources and talent of individuals)
into scarce goods – things that we would like to have.
Scarcity and Choice

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Scarcity and poverty are not the same thing.
The absence of poverty implies some basic level
of need has been met.
An absence of scarcity would imply that all of our
desires for goods are fully satisfied.
We may someday eliminate poverty, but scarcity
will always be with us.
Scarcity and Choice

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Scarcity Necessitates Rationing
Every society must have a means to ration scarce resources among competing uses.
Resources and goods can be rationed in various ways
(e.g. first-come, first served).
In a market setting, price is used to ration goods
and resources.
When price is used, the good or resource is allocated to those willing to give up “other things” in order to obtain ownership rights.
When price is used to ration goods, people have a strong incentive to earn income so they will be able
to pay the required price.

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Competition Results from Scarcity
Competition is a natural outgrowth of the need to ration scarce goods.
Changing the rationing method used by society will change the form of competition, but it will not eliminate competitive tactics.

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Questions for Thought:
1. How are grades rationed in your economics class?
How does this rationing method influence student behavior? Suppose the highest grades were rationed
to those who the teacher liked best. How would this method of rationing influence student behavior?

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The Economic Way of Thinking

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Guideposts to Economic Thinking
The use of scarce resources to produce a good or service
is always costly.
Someone must give up something if we are to have more of a scarce good.
The highest valued alternative that must be sacrificed is the opportunity cost of the choice.
Individuals choose purposefully; therefore they will economize.
Economizing:
gaining a specific benefit at the least possible cost.

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Guideposts to Economic Thinking
Incentives matter:
As personal benefits (costs) from choosing an option increase, other things constant, a person will be more (less) likely to choose that option.
Economic reasoning focuses on the impact of marginal changes.
Decisions will be based on marginal costs and marginal benefits (utility).
Since information is scarce, uncertainty is a fact of life.
In addition to their initial impact, economic events often generate secondary effects that may be felt only with the passage of time.

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Guideposts to Economic Thinking
The value of a good is subjective and varies with individual preferences.
The test of an economic theory is its ability to predict
and explain events in the real world.

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Questions for Thought:
1. In an effort to promote energy conservation, Congress mandates a minimum average gas mileage that car producers must achieve for the cars that they sell. Can you think of any secondary effects of these mandates that will conflict with energy conservation? With auto safety?
2. “The government should provide goods such as health care, education, and highways because it can provide them free.” — Is this true or false?
3. Would sound policy attempt to reduce pollution emissions to zero? Why or why not.

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Positive & Normative Economics

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Positive Economics
Positive Economics:
The scientific study of “what is” among economic relationships.
Positive economic statements involve potentially verifiable statements.
Example:
The inflation rate rises when the money supply
is increased.

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Normative Economics
Normative Economics:
Judgments about “what ought to be” in economic matters.
Normative statements reflect subjective values.
They cannot be proved true or false.
Example:
The inflation rate should be lower.

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Pitfalls to Avoid in
Economic Thinking

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Four Pitfalls
Violation of the ceteris paribus condition
Latin term meaning “other things constant.”
When describing the effect of a change, the outcome
may be influenced by changes in other things.
Good intentions do not guarantee desirable outcomes.
An unsound proposal will lead to undesirable outcomes even if it is supported by proponents with good intentions.
Politicians may be able to gain by focusing attention on a problem even if their policy response is ineffective or even harmful.

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Four Pitfalls
Fallacy of composition
The erroneous view that what is true for the individual (or the part) is also true for the group
(or the whole).
Microeconomics focuses on narrowly defined units, while macroeconomics is focused on highly aggregated units.
One must beware of the fallacy of composition when shifting from micro- to macro-units.
Association is not causation.
Statistical association alone cannot establish causation.

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Questions for Thought:
1. Which of the following are positive economic statements and which are normative?
(a) The speed limit should be lowered to 55 miles per hour on interstate highways to reduce the number of deaths and accidents.
(b) Higher gasoline prices cause the quantity of gasoline that consumers buy to increase.
(c) A comparison of costs and benefits should not be used to assess environmental regulations.
(d) Taxes on alcohol result in less drinking and driving.

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Questions for Thought:
2. “Economist, n. – A scoundrel whose faulty vision sees things as they really are, not as they ought to be.”
(chapter-opening quote)
What is the underlying message of this definition from Ambrose Bierce? Does it indicate that economists think with their heads or their hearts? Is this good or bad?
3. Suppose you were spending your own money to buy a new entertainment center (TV, DVD player, etc) for your apartment. Would you have an incentive to economize?
Suppose your parents had given you permission to buy whichever entertainment center you wanted with their money. Would that influence what you buy?

Why or why not?

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End of
Chapter 1

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Some Tools of the Economist

GWARTNEY – STROUP – SOBEL – MACPHERSON

To Accompany: “Economics: Private and Public Choice, 15th ed.”
James Gwartney, Richard Stroup, Russell Sobel, & David Macpherson
Slides authored and animated by: James Gwartney & Charles Skipton
Full Length Text —
Micro Only Text —
Part: 1
Part: 1
Chapter: 2
Chapter: 2
Macro Only Text —
Part: 1
Chapter: 2

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What Shall We Give Up?

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Opportunity Cost
Opportunity cost:
The highest valued activity sacrificed in making a choice.
Opportunity costs are incurred when a choice is made.
They are subjective and vary across persons.
If an option becomes more costly, an individual will be
less likely to choose it.

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Opportunity Cost
All choices involve costs.
Consider the costs of going to college.
The opportunity cost of going to college includes:
Monetary cost: tuition, books.
Non-monetary cost: forgone earnings.
If the opportunity cost of college rises (e.g. tuition rises or you get a fantastic job offer) then one will
be less likely to attend college.

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Trade Creates Value

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Trade and Transactions Costs
Mutual gain is the foundation of trade.
Value can be created by exchanges that move goods
to individuals who value them more.
Transactions costs:
the time, effort, and other resources needed to search out, negotiate, and consummate an exchange.
Transactions costs reduce our ability to produce gains
from potential trades.
How does the Internet reduce transactions costs and
thereby enhance trade?
Examples: eBay, iTunes, Amazon.com.

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Trade and the Middleman
Middleman:
A person who buys and sells, or arranges trades.
Middlemen reduce transactions costs.
Example:
your local grocer reduces the transactions costs of your acquiring vegetables from farmers, milk from diaries, and other products from food manufacturers.

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Questions for Thought:
It takes 1 hr. to travel from New York to D.C. by air, but
it takes 5 hrs. by bus. If the air fare is $110 and the bus fare is $70, which is cheaper for someone whose opportunity cost of travel time is $6 per hour? How about for someone whose opportunity cost is $10 per hour? $14 per hour?
Consider the choices of women aged 30 to 50 years old with (a) a college education or (b) less than a high school education. In which case will the share of women in the work force be highest? Which will have the higher average number of children? Why?

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Questions for Thought:
3. Why do people engage in exchange? Why do you trade for so many goods instead of just producing them yourself?
4. In many states, the resale of tickets to sporting events at prices above the original purchase price (“ticket scalping”) is prohibited. Is this a good idea? Who is hurt and who is helped by this prohibition?

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The Importance of Property Rights

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Private Property Rights
Property rights:
The right to use, control, and obtain benefits from
a resource, good, or service.
Private property rights involve:
the right to exclusive use.
legal protection against invaders.
the right to transfer to another.

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Private Property and Incentives
Private ownership is a key to prosperity as it provides people with a strong incentive to take care of things and develop resources in ways that are valued by others.
Private owners can gain by using their resources in ways beneficial to others.
They have a strong incentive to care for and manage what they own.
They have an incentive to conserve for the future (especially if the property’s value is expected to rise).

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Private Property and Incentives
Private ownership is a key to prosperity as it provides people with a strong incentive to take care of things and develop resources in ways that are valued by others.
(continued…)
With private property rights, owners are liable if
their property is used in a manner that damages
the property of others.
Private ownership links responsibility with the
right of control.
In contrast, commonly owned property will be poorly maintained and over-utilized rather than conserved for future use.

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Private Property and Markets
When private property rights are protected and enforced, permission of the owner is required for use of a resource.
If you want to use a good or resource, you must either buy or lease it from the owner.
Individuals and firms are faced with the cost of using
scarce resources.
Market prices provide a strong incentive for private owners to consider the desires of others and to use and develop resources that are highly valued by others.

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Questions for Thought:
1. (a) Can private owners do anything they want with the things that they own?
(b) Why is private ownership important?
(c) Do the owners of land and buildings near your campus have an incentive to use those assets to provide things that students value highly? Why or why not?
2. Does a 60 year old tree farmer have an incentive to plant and care for Douglas fir trees that will not reach optimal cutting size for 50 years? Explain.

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Questions for Thought:
3. Selling your organs is a violation of federal law, a felony punishable by up to five years in prison or a $50,000 fine. A few years ago, eBay intervened when a person put one of his kidneys up for sale on eBay (the bidding reached $5.7 million before it was pulled).
If you were largely incapacitated because of failure of you kidneys, how much would you be willing to pay to receive a healthy kidney? Is the United States a better place to live because such transactions are prohibited?
Note: people are born with 2 kidneys and can live a perfectly normal life with only one kidney.

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The Production Possibilities Curve

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Production Possibilities Curve
for Susan’s grades in English and Economics with 10 hours of study
Susan is a student who only has 10 hours of study to divide between her economics and English classes.
If she spends most of her time studying economics, she can earn an A in econ …
If she splits her time between the two, she can earn a B in economics…
If she spends most of her time studying English, she can earn a D in economics …
Mapping out all the ways Susan can divide her time (limited resources) between these activities shows us her Production Possibilities Curve ( PPC ).

A
A
B
B
C
C
D
D
Expected
grade in
Economics 101
Expected
grade in
English 101

F
F

Production Possibilities
Curve (PPC)

and a D in her English class.
and
a B in English.
and an A in English.

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Production Possibilities Curve
for a nation’s economy (given limited resources)
Consider an economy which has limited resources to divide between
the production of clothing and food.
If it allocates all of its resources toward the production of clothing, then it can produce at point S.
– Inefficiency –

Output
of clothing
Output
of food

A
D
B
C
T
S

Production Possibilities
Curve (PPC)

Only clothing
is produced

Only food
is produced

All output
combinations
on the frontier
curve are
efficient.
Mapping all the possibilities gives the their Production Possibilities Curve.
Output combinations A, B, & C are all on the PPC and are, therefore, efficient allocations of resources.
D is within the PPC and represents an inefficient resource allocation (as B delivers more food w/ the same clothing).
If it allocates all of its resources toward the production of food, then it can produce at point T.

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Shifting the Production
Possibilities Curve Outward
An increase in the economy’s resource base would expand our ability to produce goods and services.
Advancements in technology can expand the economy’s production possibilities.
An improvement in the rules (laws, institutions, and policies) of the economy can increase output.
By working harder and giving up current leisure, we could also increase our production of goods and services.
This requires us to give up something we value: leisure.

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Investment and Production
Possibilities in the Future
The long-term benefits of investment include greater future output. Thus, decisions we make today regarding how much to save (investment) and consume determine the shape of the PPC 10 years from now.
If we choose to produce a mixture
of consumption and investment goods which corresponds to bundle A …
then the future PPC might move out
to PPC 2024 with A – due to the new buildings, equipment, training, and other forms of investment goods that
IA represents.
Investment
goods
Consumption
goods

IA
CA
A

PPC 2014

PPC 2024 with A

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Investment and Production
Possibilities in the Future
If we choose to produce a mixture of consumption and investment goods which corresponds to bundle B, with fewer consumption goods (CB < CA) and more investment (IB > IA) … then the future PPC might move out to PPC 2024with B instead.
The level of investment (savings) in an economy is only one determinant of the movement outward (or inward) of the production possibilities curve.
Investment
goods
Consumption
goods

IA
CA
A

PPC 2024 with A

PPC 2024 with B
B
IB
CB

PPC 2014

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Trade, Output, and Living Standards

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Division of Labor
The division of labor:
breaks down the production of a good into a series
of tasks performed by different workers.
Specialization and the division of labor increase output for three reasons:
Specialization permits individuals to take advantage
of their existing skills.
Specialized workers become more skilled with time.
Division of labor allows for the adoption of mass-production technology.

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Law of Comparative Advantage
Law of comparative advantage:
The proposition that the joint output of trading partners will be greatest when each good is produced by the low opportunity cost producer.
Implies that trading partners can gain by specializing in the production of goods they can produce at a relatively low opportunity cost and trade for goods they could only produce at a relatively high opportunity cost.
The principle of comparative advantage is universal as it applies across individuals, firms, regions and countries.

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Sources of Gains from Trade
Trade is a key to prosperity because it:
channels goods toward those who value them the most, and,
makes it possible for people to produce more as the result of specialization & division of labor, large-scale production processes, and the dissemination of improved products and lower cost production methods.
Economies of Scale: oftentimes large scale production leads to lower per unit costs.
Innovation: technological change is about figuring out how to get more from existing resources.
Gains from trade underlie modern living standards.

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Human Ingenuity and
the Creation of Wealth

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Human Ingenuity
Is the size of the “economic pie” fixed or variable?
At any point in time, an economy’s output is limited
by it’s resource base. The production possibilities curve highlights this point.
Over time, investment and improvements in technology permit us to increase output. Shifts in the production possibilities curve highlight this point.
Economic goods are the result of human ingenuity and action. Through time, the size of the “economic pie” is variable, not fixed.

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Economic Organization

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The Three Basic Questions
Faced by All Economies
The three basic questions faced by all economies are:
What goods will be produced?
How will goods be produced?
For whom will goods be produced?

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Market Organization
Market organization:
A method of organization that allows for unregulated prices and the decentralized decisions of private property owners to resolve the basic economic problems.
Sometimes called capitalism.

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Political Planning
Political organization is the major alternative to the
use of markets.
Political organization involves the use of collective decision making (government) to decide what, how,
and for whom goods and services will be produced.
An economic system in which the government owns the income-producing assets and directly determines what goods they produce is called socialism.
In a democracy, political decision makers have to consider how their actions will influence their election prospects.

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Questions for Thought:
1. Suppose Amy is a doctor who has records that need to be entered. Doing the work herself would take 10 hours per week. She is thinking about hiring an assistant who could do the work in 40 hours per week. If Amy can make $80 per hour seeing patients, should she hire the assistant at $10 an hour to enter her records?
2. Do you make the food that you consume and clothing you wear? Would you be better off if you did not buy so many things from others? Would modern living standards be possible without trade? Would Americans be better off if they did not buy so many things from foreign producers?

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Questions for Thought:
3. What does a production-possibilities curve demonstrate? Can an economy’s production possibilities be increased?
If so, how?
4. What is the law of comparative advantage? Do people have an incentive to trade for things they can produce only at a high cost? Explain.
5. “Modern living standards are primarily the result of brain power, capital formation, & the quality of institutions.”
What is the meaning of this statement? Is it true?

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End of
Chapter 2

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The Economics
of Social Security

GWARTNEY – STROUP – SOBEL – MACPHERSON

To Accompany: “Economics: Private and Public Choice, 15th ed.”
James Gwartney, Richard Stroup, Russell Sobel, & David Macpherson
Slides authored and animated by: James Gwartney & Charles Skipton
Full Length Text —
Micro Only Text —
Part: 6
Part: 5
Special Topic: 2
Special Topic: 2
Macro Only Text —
Part: 5
Special Topic: 2

First

page

Introduction to the Social Security Program in the United States

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Social Security in the United States
The Social Security program in the U.S.:
Offers protection against the loss of income that usually accompanies old age or the death of a breadwinner.
Is a pay-you-go system.
It is not based on the saving-and-investment model.
Is an intergenerational income‑transfer program
– most taxes collected from the present generation of workers are used to finance current benefits.
Because of the pay-as-you-go nature of the U.S. Social Security program, it is greatly influenced by changing demographics.

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Workers Per Social Security Beneficiary
1950
2010
2030
In 1950, there were 16.5 workers per social security recipient.
By 2010, the figure had fallen to only 2.9.
By 2030, there will be only 2.2 workers per retiree.
As the worker / beneficiary ratio falls, a pay-as-you-go system becomes less viable.

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Why is Social Security
Headed for Problems?

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The U.S. Population 65 and over:
1980 –2010 and Projections to 2030
The growth rate of the elderly population will accelerate as the baby boomers move into the retirement phase of life during the years following 2010.
This will place strong pressure on both the Social Security and Medicare programs.

U.S. Population Age 65 and Over
(in millions)
1980
1990
2000
2020
2010
0
20
40
60
80
2030

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Coming Deficit Between Payroll Tax
Revenues and Benefit Expenditures
Given current payroll taxes and retirement levels, the Social Security system will run larger and larger deficits during the 2010-2030 period
and beyond.
Operating surpluses
build trust fund assets
Operating deficits
deplete trust fund assets
% of OASI
taxable payroll
10
12
14
16
1993
1998
2003
2008
2013
2018
2023
2028
2033
2040

Social Security tax revenues
to finance retirement benefits

Social Security outlays

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Will the Trust Fund Make it Easier to Deal With the Retirement
of the Baby-Boomers?

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The Social Security Trust Fund
Between 1980 and 2010, the social security system ran surpluses that were allocated into a trust fund “invested”
in government bonds (the Social Security Trust Fund – SSTF). But the revenues from these bonds were spent by Congress.
Will the trust fund fund make it easier to deal with the retirement of the the baby boomers? No, because:
The government both pays and receives the interest
on the bonds. They are not like the bonds, stocks, and physical assets held by a private insurance company.
The SSTF bonds are an IOU from the Treasury to the
Social Security Administration. Thus, their net asset value to the federal government is zero.
Higher taxes or revenue from other sources will be required to redeem the bonds.

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The Real Problem Created
by the Current System

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The Social Security Problem
As the large baby boom generation continues to retire, expenditures from the system will persistently increase relative to revenues.
Payroll tax revenues are now insufficient to pay promised benefits.
Under current law, revenues will only be sufficient to pay about three-quarters of the promised benefits by 2030.
There are only 4 ways to cover the shortfalls:
cut benefits,
increase taxes,
cut spending in other areas, or
borrow.
None of these options are attractive.

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Does Social Security
Help the Poor?

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Social Security and the Poor
Social Security is financed using a flat tax rate applied up
to the income cut-off limit, but the formula used to calculate benefits disproportionately favors workers with low lifetime earnings.
While the benefit formula is favorable to the poor, other aspects of the system are not. (continued on next slide)
Because low income (and poorly educated) workers have higher mortality rates (and a shorter life expectancy), they are more likely to pay into the system for many years and die before drawing benefits.
Low-wage workers generally begin full-time work at a younger age and therefore pay more into the system earlier (and forego more interest).

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While the benefit formula is favorable to the poor, other aspects of the system are not. (continued …)
Couples with a high-wage worker are more likely to gain from Social Security’s spousal benefit provision, which provides the non-working spouse with benefits equal to 50% those of the working spouse.
Social Security may actually transfer income modestly away from the poor.
(See accompanying slide)
Social Security and the Poor

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Mortality Rates by Level of Education
As shown here,
the age-adjusted mortality rate is inversely related
to education (and income). So too
is life expectancy.

+ 8%
+ 10%
+ 9%
+ 9%
– 4%
– 8%
– 21%
– 32%
0-4
5-7
8
1-3
4
1-3
4
– Elementary –
– High School –
– College –
–––––––––––––––– Highest Grade Completed ––––––––––––––––
Graduate
School
–
–
Age-Adjusted Mortality Rate
U.S.
Avg
Source: Center for Data Analysis, Heritage Foundation.

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Social Security and the
Treatment of Blacks and
Working Married Women

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The Impact of Social Security
on Minorities and Working Women
Because of their shorter life expectancy, blacks derive a lower rate of return from Social Security than whites, and a substantially lower return than Hispanics.
(See following slide.)
Many married women in the labor force are eligible for benefits (based on the earnings of their spouse) that are approximately equal to, or in some cases greater than, benefits based on their own earnings. Thus, they derive few, if any, benefits from the taxes they pay into the system.

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Rates of Return by Gender,
Marital Status, and Ethnicity
Whites derive a higher real rate of return from Social Security contributions than blacks, but Hispanics derive a return that is even higher than whites.
Can you explain why?

– 1.3 %

0.2 %
1.6 %
2.3 %
3.0 %
1.8 %
1.2 %
2.3 %
0.5 %
Male
(single)
Female
(single)
Married
(2-earner family)
Blacks
Whites
Hispanics
Real Annual Projected Rate of Return
on Social Security Contributions (%)

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Is the Structure of Social Security Suitable for the 21st Century?

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The Future of Social Security
When the number of retirees is growing more rapidly than the number of workers, a pay-as-you-go system does not work well.
Because of changing demographics, the Social Security and Medicare systems now confront huge unfunded liabilities
— shortfalls between promised future benefits and revenues expected at current tax rates.
According to Social Security and Medicare Trustees, the unfunded liabilities are:
$12 trillion for Social Security, and,
$27 trillion for Medicare.
The shortfalls in the systems ($39 trillion) are approximately two and a half times the size of the current U.S. economy.

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Personal Retirement Accounts
The outdated structure of Social Security and size of the unfunded liability may force congress to consider modifications.
The most viable solution would be some form of personal retirement accounts that would incorporate personal ownership and the saving – investment principle.
Several countries have moved in this direction (Chile,
United Kingdom, Sweden, Germany, & the Netherlands
are each examples).
With personal ownership, the disincentive effect of payments into a retirement account would be substantially less than the taxes of the current system.

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Questions for Thought:
Are the following statements true or false?
(a) The Social Security benefit formula works to the advantage of low-wage workers.
(b)Compared to those with higher earnings, on average,
low-wage workers are more likely to pay thousands of dollars in Social Security taxes and then die before, or soon after, becoming eligible for retirement benefits.
(c) Social Security works to the disadvantage of groups with below average life expectancy.

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Questions for Thought:
2. In order to redeem the bonds in the Social Security Trust Fund, the federal government will have to:
(a) raise taxes, reduce spending on other programs, or
increase its borrowing.
(b) draw down Social Security bank deposits that have
been set aside to pay future benefits.
(c) sell private equity investments that the government
has been purchasing with Social Security
contributions.

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Questions for Thought:
3. Are the following statements true or false?
(a) Only about 80% of the current revenues flowing into
the Social Security system are needed for benefit
payments to current retirees.
(b) Between 1980 and 2010, most of the social security
surplus was used to reduce the national debt.
(c) Changes in demographic conditions during the next
two decades will be favorable to the Social Security
system.

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Questions for Thought:
4. Will the funds currently being built up in the Social Security Trust Fund help keep federal taxes low when the baby boom generation retires? Why or why not?
5. How does the Social Security system influence the economic status of blacks? How does it influence the economic status of Hispanics?

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End of
Special Topic 2

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